Dispositions of Partnership Interests and Partnership Distributions Solutions Manual Discussion Questions

Chapter 10 - Dispositions of Partnership Interests and Partnership Distributions
Chapter 10
Dispositions of Partnership Interests and Partnership Distributions
SOLUTIONS MANUAL
Discussion Questions
1. [LO 1] Joey is a 25% owner of Loopy LLC. He no longer wants to be involved in the
business. What options does Joey have to exit the business?
Answer:
Joey’s two most common options are to sell or exchange his interest in the LLC to a
third party or to have the LLC liquidate his interest. Joey may also exchange his
interest for corporate stock, give the interest away, or transfer the interest upon his
death.
2. [LO 1] Compare and contrast the aggregate and entity approaches for a sale of a
partnership interest.
Answer:
Under the aggregate approach, the disposition of a partnership interest represents a
sale of the partner’s share of each of the partnership assets. This approach would
require complex tax rules because the partner would need to allocate the sales proceeds
among the different assets and determine the character of the gain or loss from each
asset.
Under the entity approach, the sale of a partnership interest would be very similar to
the sale of corporate stock. The partner would recognize capital gain or loss on the sale
based on the difference between the sales price and the partner’s tax basis in the
3. [LO 1] What restrictions might prevent a partner from selling his partnership interest to a
third party?
Answer:
Partnership agreements may specify whether a partner may voluntarily leave the
partnership. If the agreement does not allow for a voluntary withdrawal, the
partnership may need to be dissolved to effect the termination.
A partnership agreement may also specify whether a partner may assign his interest to
a third party. This will determine if the partner is free to sell his interest to someone
other than the existing partners.
10-1
4. [LO 1] Explain how a partner’s debt relief affects his amount realized in a sale of
Answer:
When a partner sells his partnership interest, often he is relieved of his partnership
debt obligations. As is the case in sales of other assets, debt relief will increase the
amount realized in the sale of a partnership interest. Because the partner’s outside
basis includes his share of the partnership debt, this negates the effect of debt on the
gain or loss of the partnership interest sale.
5. [LO 1] Under what circumstances will the gain or loss on the sale of a partnership
interest be characterized as ordinary rather than capital?
Answer:
To the extent that a gain or loss on the sale of a partnership interest is attributable to
certain ordinary income assets held by the partnership, the gain or loss is ordinary.
§751(a) defines the assets for which the gain or loss will be treated as ordinary.
6. [LO 1] What are “hot assets” and why are they important in the sale of a partnership
interest?
Answer:
Hot assets are assets defined in §751 that will re-characterize the portion of a gain or
loss on the sale of a partnership interest as ordinary. The two categories of hot assets
under §751(a) are unrealized receivables and inventory items. Unrealized receivables
include rights to receive payment for goods delivered or to be delivered, rights for
services rendered or to be rendered, and items treated as ordinary income if the
partnership were to sell the item at its fair market value.
Under §751(a) inventory items include property held for sale to customers in the
ordinary course of business and assets that are not capital assets or §1231 assets that
would produce ordinary income if sold by the partnership. To the extent that a seller
realizes any amounts from the sale of his partnership interest that are attributable to
these unrealized receivables or inventory items, the gain or loss will be classified as
ordinary.
7. [LO 1] For an accrual-method partnership, are accounts receivable considered unrealized

receivables? Explain.
Answer:
No. For accrual-method taxpayers, accounts receivable are not considered unrealized
receivables because these amounts have already been realized and recognized as
ordinary income.
10-2
8. [LO 1] Can a partnership have unrealized receivables if it has no accounts receivable?
Answer:
The definition of unrealized receivables is broad enough to encompass assets other
than accounts receivable. §751(a) also includes assets that are NOT capital assets or
§1231 assets that would produce ordinary income if sold by the partnership. Items
such as depreciation recapture are also classified as unrealized receivables. Thus, a
partnership can have unrealized receivables without having accounts receivable.
9. [LO 1] How do hot assets affect the character of gain or loss on the sale of a partnership
interest?
Answer:
Hot assets cause a portion of the gain or loss on the sale of a partnership interest to be
classified as ordinary rather than capital.
10. [LO 1] Under what circumstances can a partner recognize both gain and loss on the sale
of a partnership interest?
Answer:
A partner may recognize both gain and loss on the sale of a partnership interest in the
situation where a partner’s share of the unrealized gain in hot assets is greater than
his total gain or loss on the sale of his partnership interest.
11. [LO 1] Absent any special elections, what effect does a sale of partnership interest have
on the partnership?
Answer:
When one partner sells his partnership interest, the sale generally has no effect on the
partnership. However, if the partnership interest that is sold is large, the sale may
terminate the partnership for tax purposes.
12. [LO 1] {Research} Generally, a selling partner’s capital account carries over to the
purchaser of the partnership interest. Under what circumstances will this not be the case?
Answer:
In the case where the selling partner contributed built-in loss property to the
partnership, the buyer’s capital account will be reduced by the amount of the inherent
loss at the partnership interest sale date. This treatment ensures that only the partner
that contributed the built-in loss property to the partnership benefits from the
inherent loss.
13. [LO 2] What distinguishes operating from liquidating distributions?
10-3
Answer:
Operating or current distributions are made to partners whose interests in the
partnership continue after the distribution. Liquidating distributions terminate a
partner’s interest in the partnership.
14. [LO 3] Under what circumstances will a partner recognize a gain from an operating
distribution?
Answer:
In general, partners do not recognize gain or loss from operating distributions.
However, when the partnership distributes money that exceeds a partner’s basis in her
partnership interest, she will recognize a gain equal to the excess. In this situation, the
partner is unable to adjust the basis in property distributed in order to defer the gain.
15. [LO 3] Under what circumstances will a partner recognize a loss from an operating
distribution?
Answer:
A partner never recognizes loss from operating distributions.
16. [LO 3] In general, what effect does an operating distribution have on the partnership?
Answer:
The partnership does not generally recognize gain or loss for tax purposes when
making an operating distribution. This contrasts with the tax treatment of corporate
distributions in which the corporation recognizes gain or loss on distributions of
property other than cash.
17. [LO 3] If a partner’s outside basis is less than the partnership’s inside basis in distributed
assets, how does the partner determine his basis of the distributed assets in an operating
distribution?
Answer:
If only money is distributed, the partner recognizes gain equal to the difference
between the money distributed and the basis in the partnership interest. If the
partnership distributes money and hot assets only, the partner defers gain recognition
by reducing the basis of the hot assets distributed. The partner first allocates basis to
the assets received equal to the partnership basis (allocating to money first). Then, the
partner allocates the required decrease (difference between the partnership’s basis in
the distributed assets and the partner’s outside basis) to the assets with unrealized
depreciation. Finally, the partner allocates any remaining required decrease to the
distributed assets in proportion to their adjusted bases.
10-4
If the partnership distributes other property in addition to money and hot assets, the
partner defers gain by reducing the basis in the other property distributed. The
partner first assigns basis to the distributed assets equal to the partnership basis. The
partner then allocates the required decrease to property other than money, inventory
and unrealized receivables to the extent of the unrealized depreciation in the assets.
Finally, the partner allocates any remaining required decrease to the other property in
proportion to the assets’ adjusted bases.
18. [LO 4] Under what conditions will a partner recognize gain in a liquidating distribution?
Answer:
In the situation in which a partnership distributes only money and the amount exceeds
the partner’s basis in her partnership interest, she will recognize a gain equal to the
excess. In this situation, the partner is unable to adjust the basis in property
distributed in order to defer the gain.
19. [LO 4] Under what conditions will a partner recognize loss in a liquidating distribution?
Answer:
When a distribution includes only cash, unrealized receivables, and inventory and the
partner’s basis in his partnership interest is greater than the sum of the bases of the
distributed assets, the partner will recognize a loss on a liquidating distribution. The
partner treats the loss as a capital loss.
20. [LO 4] Describe how a partner determines his basis in distributed assets in cases in which
a partnership distributes only money, inventory, and/or unrealized receivables in a
liquidating distribution.
Answer:
If the partner’s basis in the partnership interest is greater than the basis of the
distributed assets, the partner is unable to defer loss without changing the character of
the loss. Therefore, the partner assigns a basis to the money, inventory, and unrealized
receivables equal to the partnership’s basis in the distributed assets. The partner
recognizes a capital loss equal to the remaining outside basis after the distributed
assets have been assigned a carryover basis.
If the partner’s basis in the partnership interest is less than the basis of the distributed
assets, the partner defers gain recognition by reducing the basis of the hot assets
distributed. The required decrease is equal to the difference between the partnership’s
basis in the distributed assets and the partner’s outside basis. The partner allocates
the required decrease to assets with unrealized depreciation first to eliminate existing
losses in the distributed assets. Then the partner allocates any remaining required
decrease to the distributed assets in proportion to their adjusted bases.
10-5
21. [LO 4] How does a partner determine his basis in distributed assets when the partnership
distributes other property in addition to money and hot assets?
Answer:
If the partner’s basis in the partnership interest is greater than the basis of the
distributed assets, the partner defers loss recognition by increasing the basis of the
other property distributed. The required increase equals the difference between the
partner’s outside basis and the partnership bases in the distributed assets. The partner
first assigns a basis to the distributed assets equal to the partnership’s basis. The
partner then allocates the required increase to the other property with unrealized
appreciation. Finally, the partner allocates any remaining required increase to the
other property in proportion to their fair market values.
When the partnership distributes other property in addition to money, inventory, and
unrealized receivables and the partner’s basis in the partnership interest is less than
the basis of the distributed assets, the partner defers gain by reducing the basis in the
other property distributed. The partner first assigns basis to the distributed assets
equal to the partnership basis. The partner then allocates the required decrease to
property other than money, inventory and unrealized receivables to the extent of the
unrealized depreciation in the assets. Finally, the partner allocates any remaining
required decrease to the other property in proportion to the assets’ adjusted bases.
22. [LO 5] {Planning} SBT partnership distributes $5,000 cash and a parcel of land with a
fair market value of $40,000 and a $25,000 basis to the partnership to Sam (30% partner).
What factors must Sam and SBT consider in determining the tax treatment of this
distribution?
Answer:
SBT and Sam must determine if the distribution is an operating or a liquidating
distribution. Sam may not recognize a loss if the distribution is an operating
distribution. Sam must also consider whether the distributed cash exceeds her basis in
SBT. If so, she will recognize a gain on the distribution.
SBT and Sam must also consider whether the distribution is a disproportionate
distribution. To the extent that SBT has any hot assets, this distribution to Sam will
represent a disproportionate distribution that can cause both Sam and SBT to
recognize gain or loss on the distribution. Finally, Sam must determine her basis in the
distributed land. Her determination of basis will depend on whether the distribution is
an operating or a liquidating distribution.
10-6
23. [LO 5] Discuss the underlying concern to tax policy makers in distributions in which a
partner receives more or less than his share of the partnership hot assets.
Answer:
If a partner’s share of hot assets is altered from a distribution, the primary concern is
that the partner will convert capital gain or loss to an ordinary gain or loss. Thus if a
partnership has §751 property, the partnership must determine whether any
distribution is proportionate or disproportionate. If the distribution is
disproportionate, the tax rules require the application of a complex set of rules to
ensure that the distributee partner recognizes a proportionate amount of ordinary and
capital gain or loss commiserate to his interest in the partnership.
Most operating distributions are proportionate and do not require the application of
these rules. However, in cases where a partner is reducing his interest in the
partnership (e.g., from 40% to 25%) or in liquidating distributions, the application of
these rules is more commonplace.
24. [LO 5] In general, how do the disproportionate distribution rules ensure that partners
recognize their share of partnership ordinary income?
Answer:
Basically, the tax rules require partners to treat disproportionate distributions as
though three separate events occur. To illustrate, assume a partner’s interest in the
partnership hot assets decreases as a result of the distribution. First, the partner is
treated as though a hypothetical current distribution of the hot assets occurs. The
partner is treated as though she receives the fair market value of the decrease in hot
assets as a current distribution.
Next, the rules require the partner to act as though she has sold the hot assets received
in the hypothetical distribution to the partnership for an amount equal to the amount
of the cold assets that her interest increases.
Finally, the last step is to treat the amount of the distribution that is proportionate as a
normal distribution.
10-7
25. [LO 6] {Planning} Why would a new partner who pays more for a partnership interest
than the selling partner’s outside basis want the partnership to elect a special basis
adjustment?
Answer:
An investor who pays more for a partnership interest than the seller’s outside basis
essentially has already paid for his share of any appreciation in the partnership’s
assets. However, absent a special basis adjustment, the buyer inherits the seller’s
inside basis, which does not reflect the gain realized on the sale of the partnership
interest. As the partnership sells the appreciated assets, the partner’s recognize their
share of the gain from the appreciated assets as a part of their annual distributive
share of the partnership income.
This means that the buyer pays for the appreciation of the assets as part of the
acquisition price of the partnership interest AND recognizes gain again when the
partnership recognizes income from the sale of the appreciated assets. Only upon the
sale of his partnership interest will the over-taxation resolve itself. The special basis
adjustment under §754 eliminates the disparity between a new partner’s inside and
outside basis.
26. [LO 6] List two common situations that will cause a partner’s inside and outside basis to
differ.
Answer:
The most common situations in which discrepancies between inside and outside bases
occur are following sales of partnership interests and following distributions in which
a partner receives more or less than her share of the inside basis in the partnership
property.
27. [LO 6] Explain why a partnership might not want to make a §754 election to allow
special basis adjustments.
Answer:
Once the partnership makes a §754 election, the election is binding for all future sales
and distributions. The election may only be revoked with the consent of the IRS. The
election may not always be advantageous and limits the partnership’s and partners’
ability to tax plan. For example, if partnership assets decrease in value, an incoming
partner will have a downward basis adjustment.
10-8
28. [LO 6] When might a new partner have an upward basis adjustment following the
acquisition of a partnership interest?
Answer:
A new partner will have an overall upward basis adjustment when he purchases an
interest in the partnership for an amount greater than his inside basis immediately
following the acquisition. Although the overall basis adjustment results in an increase
in asset bases, it is possible for some individual asset bases to decrease if the asset has
declined in value while held by the partnership.
29. [LO 6] Are special basis adjustments mandatory? If so, when?
Answer:
Two cases require a mandatory special basis adjustment. First, when a partnership
has a substantial built-in loss at the time of a sale of a partnership interest, the
adjustment is required. A substantial built-in loss occurs when the partnership’s
adjusted basis in its assets exceeds the fair market value of the assets by more than
$250,000.
The second case where a mandatory special basis adjustment must be made is for
distributions where there is a substantial basis reduction. A substantial basis reduction
exists if the negative adjustments from a special basis adjustment exceed $250,000.
Recall that negative basis adjustments only occur in liquidating distributions.
Problems
30. [LO 1] Jerry is a 30% partner in the JJM Partnership when he sells his entire interest to
Lucia for $56,000 cash. At the time of the sale, Jerry’s basis in JJM is $32,000. JJM does
not have any debt or hot assets. What is Jerry’s gain or loss on the sale of his interest?
Answer:
Jerry will determine his gain or loss as the difference between the amount realized on
the sale and his basis in the partnership interest.
Amount realized $ 56,000
Less: Adjusted basis (32,000)
Gain recognized on the sale $24,000
10-9
31. [LO 1] Joy is a 30% partner in the JOM Partnership when she sells her entire interest to
Hope for $72,000 cash. At the time of the sale, Joy’s basis in JOM is $44,000 (which
includes her $6,000 share of JOM liabilities). JOM does not have any hot assets. What is
Joy’s gain or loss on the sale of her interest?
Answer:
Joy determines her gain or loss as follows:
Amount realized
Cash $72,000
Debt relief 6,000 $78,000
Less: Outside basis in JOM (44,000)

Gain recognized on the sale $34,000
32. [LO 1] Allison, Keesha, and Steven each own equal interests in KAS partnership, a
calendar year-end, cash-method entity. On January 1 of the current year, Steven’s basis in
his partnership interest is $27,000. During January and February, the partnership
generates $30,000 of ordinary income and $4,500 of tax exempt income. On March 1,
Steven sells his partnership interest to Juan for a cash payment of $45,000. The
partnership has the following assets and no liabilities at the sale date:
Basis FMV
Cash $ 30,000 $ 30,000
Land held for investment 30,000 60,000
Totals $ 60,000 $ 90,000
a. Assuming KAS’s operating agreement provides for an interim closing of the books
when partners’ interests change during the year, what is Steven’s basis in his
partnership interest on March 1 just prior to the sale?
b. What is the amount and character of Steven’s recognized gain or loss on the sale?
c. What is Juan’s basis in the partnership interest?
d. What is the partnership’s basis in the assets following the sale?
10-10
Answer:
a. Outside basis as of January 1: $ 27,000
Plus: distributive share of income
Ordinary 10,000
Tax exempt 1,500
Outside basis as of March 1: $ 38,500
b. Amount realized: $ 45,000
Less: basis in partnership interest (38,500)
Capital gain $ 6,500
c. Juan’s basis in his partnership interest is his cost of $45,000.

d. The partnership has a basis in its assets equal to the assets before the sale. The sale
does not affect the partnership’s basis in its assets.
33. [LO 1] Grace, James, Helen, and Charles each own equal interests in GJHC partnership, a
calendar year-end, cash-method entity. On January 1 of the current year, James’ basis in
his partnership interest is $62,000. For the taxable year, the partnership generates
$80,000 of ordinary income and $30,000 of dividend income. For the first 5 months of
the year, GJHC generates $25,000 of ordinary income and no dividend income. On June
1, James sells his partnership interest to Robert for a cash payment of $70,000. The
partnership has the following assets and no liabilities at the sale date:
Basis FMV
Cash $ 27,000 $ 27,000
Totals $ 107,000 $ 127,000
a. Assuming GJHC’s operating agreement provides that the proration method will be
used to allocate income or loss when partners’ interests change during the year, what is
James’ basis in his partnership interest on March 1 just prior to the sale?
b. What is the amount and character of James’ recognized gain or loss on the sale?
c. If GJHC uses an interim closing of the books, what is the amount and character of
James’ recognized gain or loss on the sale?
10-11
Answer:
a. Outside basis as of January 1: $ 62,000
Ordinary ($80,000 x 25% x 5/12) 8,333
Dividend ($30,000 x 25% x 5/12) 3,125
Outside basis as of June 1: $ 73,458
Capital loss $ (3,458)
c. Outside basis as of January 1: $ 62,000

Ordinary ($25,000 x 25%) 6,250
Outside basis as of June 1: $ 68,250
Amount realized: $ 70,000
34. [LO 1] At the end of last year, Lisa, a 35% partner in the five-person LAMEC
partnership, has an outside basis of $60,000 including her $30,000 share of LAMEC debt.
On January 1 of the current year, Lisa sells her partnership interest to MaryLynn for a
cash payment of $45,000 and the assumption of her share of LAMEC’s debt.
a. What is the amount and character of Lisa’s recognized gain or loss on the sale?
b. If LAMEC has $100,000 of unrealized receivables as of the sale date, what is the
amount and character of Lisa’s recognized gain or loss?
c. What is MaryLynn’s basis in the partnership interest?
Answer:
a. Amount realized:
Cash $ 45,000
Debt relief 30,000 $75,000
Lisa’s recognized capital gain $ 15,000
b. Lisa’s share of unrealized receivables is $35,000 ($100,000 unrealized receivables 

35% interest). Lisa will recognize $35,000 of ordinary income and a $20,000 capital
loss determined as:
10-12
Total gain $ 15,000

Less: Ordinary income (35,000)
Lisa’s recognized capital loss $ (20,000)
c. MaryLynn’s basis in her partnership interest is $75,000 (cash of $45,000 plus her
$30,000 share of LAMEC’s debt).
35. [LO 1] Marco, Jaclyn, and Carrie formed Daxing partnership (a calendar year-end entity)
by contributing cash 10 years ago. Each partner owns an equal interest in the partnership.
Marco, Jaclyn, and Carrie each have an outside basis in his/her partnership interest of
$104,000. On January 1 of the current year, Marco sells his partnership interest to Ryan
for a cash payment of $137,000. The partnership has the following assets and no
liabilities as of the sale date:
Basis Fair Market Value

Cash $ 18,000 $ 18,000
Accounts receivable -0- 12,000
Inventory 69,000 81,000
Equipment 180,000 225,000
Stock investment 45,000 75,000
Totals $ 312,000 $ 411,000
The equipment was purchased for $240,000 and the partnership has taken $60,000 of
depreciation. The stock was purchased 7 years ago.
a. What are the “hot assets” (§751(a)) for this sale?
b. What is Marco’s gain or loss on the sale of his partnership interest?
c. What is the character of Marco’s gain or loss?
d. What is Ryan’s inside and outside bases in the partnership on the date of the sale?
Answer:
a. The hot assets include the potential depreciation recapture in the equipment
($45,000), the accounts receivable, and the inventory.
Marco’s realized and recognized gain $ 33,000
c. To the extent Marco realizes any amounts attributable to hot assets, his gain will be
classified as ordinary. If Daxing sold its assets for their fair market value at the sale
date, the ordinary gain would be as follows:
10-13
Tax basis FMV Gain/Loss Mark’s share

Accounts receivable $ -0- $ 12,000 $ 12,000 $4,000
Inventory 69,000 81,000 12,000 4,000
Equipment 180,000 225,000 45,000 15,000
$ 69,000 $ 23,000
Total gain $ 33,000
Less: ordinary gain (23,000)
Capital gain $10,000
Marco recognizes $23,000 of ordinary income and $10,000 capital gain from the sale
of his interest in Daxing.
d. Ryan has an outside basis equal to his cost of the partnership interest: $137,000. His
inside basis is equal to Marco’s inside basis before the sale: $104,000.
Note: The partnership in problem 35 uses the cash method of accounting under Rev Proc
2001-10, which permits certain small businesses to treat inventory items as non-
incidental materials and supplies.
36. [LO 1] Franklin, Jefferson, and Washington formed the Independence Partnership (a
calendar-year-end) by contributing cash 10 years ago. Each partner owns an equal
interest in the partnership. Franklin, Jefferson, and Washington each have an outside
basis in his partnership interest of $104,000. On January 1 of the current year, Franklin
sells his partnership interest to Adams for a cash payment of $122,000. The partnership
has the following assets and no liabilities as of the sale date:

Cash $ 18,000 $ 18,000
Inventory 69,000 81,000
Equipment 180,000 225,000
Totals $ 312,000 $ 366,000
The equipment was purchased for $240,000 and the partnership has taken $60,000 of
depreciation. The stock was purchased 7 years ago.
a. What is Franklin’s overall gain or loss on the sale of his partnership interest?
b. What is the character of Franklin’s gain or loss?
Answer:
a. Amount realized: $ 122,000
Franklin’s realized and recognized gain $ 18,000
10-14
b. To the extent Franklin realizes any amounts attributable to hot assets, his gain will
be classified as ordinary. If Independence sold its assets for their fair market value
at the sale date, the ordinary gain would be as follows:
Tax basis FMV Gain/Loss Franklin’s share
Accounts receivable $ -0- $ 12,000 $ 12,000 $4,000
Inventory 69,000 81,000 12,000 4,000
Equipment 180,000 225,000 45,000 15,000
$ 69,000 $ 23,000
Total gain $ 18,000
Capital loss $(5,000)
Franklin recognizes $23,000 of ordinary income and a $5,000 capital loss from the
sale of his interest in Independence.
Note: The partnership in problem 36 uses the cash method of accounting under Rev Proc
2001-10, which permits certain small businesses to treat inventory items as non-
incidental materials and supplies.
37. [LO 1] Travis and Alix Weber are equal partners in the Tralix partnership, which does
not have a §754 election in place. Alix sells one-half of her interest (25%) to Michael
Tomei for $30,000 cash. Just before the sale, Alix’s basis in her entire partnership interest
is $75,000 including her $30,000 share of the partnership liabilities. Tralix’s assets on the
sale date are as follows:

Cash $ 40,000 $ 40,000
Inventory 30,000 90,000
Totals $ 150,000 $ 180,000
a. What is the amount and character of Alix’s recognized gain or loss on the sale?
b. What is Alix’s basis in her remaining partnership interest?
c. What is Michael’s basis in his partnership interest?
d. What is the effect of the sale on the partnership’s basis in the assets?
10-15
Answer:
a. Amount realized:
Cash $ 30,000
Debt relief 15,000 $ 45,000
Less: basis in partnership interest (1/2 of $75,000) (37,500)
Alix’s realized and recognized gain $ 7,500
To the extent Alix realizes any amounts attributable to hot assets, her gain will be
classified as ordinary. If Tralix sold its assets for their fair market value at the sale
Tax basis FMV Gain/Loss Alix’s 25%
Inventory $ 30,000 $ 90,000 $ 60,000 $ 15,000
Total gain $ 7,500
Alix recognizes $15,000 of ordinary income and a $7,500 capital loss from the sale of
half of her interest in Tralix.
b. Alix has a remaining basis in Tralix of $37,500.
c. Michael has an outside basis in his 25% interest in Tralix equal to his $30,000 cash
payment plus his 25% share of Tralix’s debt of $15,000 for a total basis of $45,000.
d. The sale has no effect on Tralix’s basis in its assets.
38. [LO 1] Newton is a one-third owner of ProRite Partnership. Newton has decided to sell
his interest in the business to Betty for $50,000 cash plus the assumption of his share of
ProRite’s liabilities. Assume Newton’s inside and outside basis in ProRite are equal.
ProRite shows the following balance sheet as of the sale date:
Assets: Basis FMV

Cash $ 80,000 $ 80,000
Receivables 25,000 25,000
Inventory 40,000 85,000
Land 30,000 20,000
Totals $ 175,000 $ 210,000
Liabilities and capital:

Liabilities $ 60,000
Capital – Newton 38,333
– Barbara 38,334
– Liz 38,333
Totals $ 175,000
What is the amount and character of Newton’s recognized gain or loss?
10-16
Answer:
Amount realized:
Cash $ 50,000
Debt relief 20,000 $ 70,000
Less: basis in partnership interest (including liabilities) (58,333)
Newton’s realized and recognized gain $11,667
To the extent Newton realizes any amounts attributable to hot assets, his gain will be
classified as ordinary. If ProRite sold its assets for their fair market value at the sale
Tax basis FMV Gain/Loss Newton’s 1/3
Inventory $ 40,000 $ 85,000 $ 45,000 $ 15,000
Total gain $ 11,667

Newton recognizes $15,000 of ordinary income and a $3,333 capital loss from the
sale of his interest in ProRite.
39. [LO 3] Coy and Matt are equal partners in the Matcoy Partnership. Each partner has a
basis in his partnership interest of $28,000 at the end of the current year, prior to any
distribution. On December 31, they each receive an operating distribution. Coy receives
$10,000 cash. Matt receives $3,000 cash and a parcel of land with a $7,000 fair market
value and a $4,000 basis to the partnership. Matcoy has no debt or hot assets.
a. What is Coy’s recognized gain or loss? What is the character of any gain or loss?
b. What is Coy’s ending basis in his partnership interest?
c. What is Matt’s recognized gain or loss? What is the character of any gain or loss?
d. What is Matt’s basis in the distributed property?
e. What is Matt’s ending basis in his partnership interest?
10-17
Answer:
a. Coy does not recognize any gain or loss on the current distribution.
b. Coy reallocates his basis in Matcoy to the cash in an amount equal to the
distribution, $10,000. His remaining basis in Matcoy is $18,000 ($28,000 - 10,000).
Basis before distribution $ 28,000
Less: Amount allocated to cash (10,000)
Equals: basis in partnership interest $ 18,000
c. Matt does not recognize any gain or loss on the current distribution.
d. Matt takes a carryover basis in the distributed property. The cash has a basis equal
to $3,000 and the land has a basis equal to $4,000 (Matcoy’s basis in the land).
e. Matt reallocates his basis in Matcoy to the cash in an amount equal to the
distribution, $3,000. Matt takes a carryover basis in the land and allocates $4,000 of
his Matcoy basis to the land. His remaining basis in Matcoy is $21,000 ($28,000 -
3,000 – 4,000).
Basis before distribution $ 28,000
Less: Amount allocated to cash (3,000)
25,000
Amount allocated to land (4,000)
Equals: basis in partnership interest $ 21,000
40. [LO 3] Justin and Lauren are equal partners in the PJenn Partnership. The partners
formed the partnership seven years ago by contributing cash. Prior to any distributions,
the partners have the following bases in their partnership interests:
Partner Outside Basis

Justin $ 22,000
Lauren 22,000
On December 31 of the current year, the partnership makes a pro-rata operating

distribution of:
Partner Distribution
Justin Cash $ 25,000
Lauren Cash 18,000
Property 7,000 (FMV) ($2,000 basis to partnership)
a. What is the amount and character of Justin’s recognized gain or loss?
b. What is Justin’s remaining basis in his partnership interest?
10-18
c. What is the amount and character of Lauren’s recognized gain or loss?
d. What is Lauren’s basis in the distributed assets?
e. What is Lauren’s remaining basis in her partnership interest?
Answer:
a. Because Justin receives only money in the distribution and the distribution exceeds
his basis in the partnership, he must recognize a gain on the current distribution.
Justin calculates his gain as the difference between his basis in the partnership and
the distribution.
Distribution of money $ 25,000
Less: Basis in PJenn (22,000)
Gain (capital) $3,000
b. Justin allocates his entire outside basis to the basis in the money received and
therefore he has a zero basis remaining in his partnership interest.
c. Lauren does not recognize any gain or loss on the current distribution.
d. Lauren takes a carryover basis in the assets distributed. She receives $18,000 cash
so she reduces her basis in PJenn by this amount. This leaves an outside basis of
$4,000 ($22,000 – 18,000). Lauren assigns a basis of $2,000 to the property
distributed as this is PJenn’s basis.
e. Lauren’s basis in PJenn following the distribution is $2,000, determined as follows:

Basis in PJenn $22,000
Less: Cash distribution (18,000)
Property (2,000)
Remaining basis in PJenn $2,000
41. [LO 3] Adam and Alyssa are equal partners in the PartiPilo Partnership. The partners
formed the partnership three years ago by contributing cash. Prior to any distributions,
the partners have the following bases in their partnership interests:
Partner Outside Basis

Adam $ 12,000
Alyssa 12,000
10-19
On December 31 of the current year, the partnership makes a pro-rata operating

distribution of:
Partner Distribution
Adam Cash $ 16,000
Alyssa Cash 8,000
Property 8,000 (FMV) ($6,000 basis to partnership)
a. What is the amount and character of Adam’s recognized gain or loss?
b. What is Adam’s remaining basis in his partnership interest?
c. What is the amount and character of Alyssa’s recognized gain or loss?
d. What is Alyssa’s basis in the distributed assets?
e. What is Alyssa’s remaining basis in her partnership interest?
Answer:
a. Because Adam receives only money in the distribution and the distribution exceeds
his basis in PartiPilo, he must recognize a gain on the current distribution. Adam
calculates his gain as the difference between his basis in the partnership and the
distribution.
Distribution of money $ 16,000
Less: Basis in Partipilo (12,000)
Gain (capital) $4,000
b. Adam allocates his entire outside basis to the basis in the money received and
therefore he has a zero basis remaining in his partnership interest.
c. Alyssa does not recognize any gain or loss on the current distribution.
d. Alyssa reduces her basis in PartiPilo by $8,000 for the cash distribution, which
leaves her with a basis of $4,000. Alyssa assigns a $4,000 basis to the property (a
reduction of $2,000).
e. Alyssa reduces her basis in Partipilo to $-0- after the distribution.

Basis in PartiPilo $12,000
Less: Cash distribution (8,000)
Property (4,000)
Remaining basis in PartiPilo $-0-
10-20
42. [LO 3] Karen has a $68,000 basis in her 50% partnership interest in the KD Partnership
before receiving a current distribution of $6,000 cash and land with a fair market value of
$35,000 and a basis to the partnership of $18,000.
a. What is the amount and character of Karen’s recognized gain or loss?
b. What is Karen’s basis in the land?
c. What is Karen’s remaining basis in her partnership interest?
Answer:
a. Karen does not recognize any gain or loss on the current distribution.
b. Karen takes a carryover basis in the land equal to $18,000.
c. Karen’s outside basis in the partnership after the distribution is as follows:
Basis in KD $68,000
Less: Distributions
Cash (6,000)
Land (18,000) (24,000)
Remaining basis in KD $44,000
43. [LO 3] Pam has a $27,000 basis (including her share of debt) in her 50% partnership
interest in the Meddoc partnership before receiving any distributions. This year Meddoc
makes a current distribution to Pam of a parcel of land with a $40,000 fair market value
and a $32,000 basis to the partnership. The land is encumbered with a $15,000 mortgage
(the partnership’s only liability).
a. What is the amount and character of Pam’s recognized gain or loss?
b. What is Pam’s basis in the land?
c. What is Pam’s remaining basis in her partnership interest?
10-21
Answer:
a. Pam must consider the effects of debt changes before determining the effects of the
distribution. Pam is treated as making a net contribution of cash to the partnership
of $7,500, the difference between the full mortgage of $15,000 and her allocated
share of the debt of $7,500. This deemed contribution increases Pam’s basis in
Meddoc from $27,000 to $34,500. Pam does not recognize any gain or loss on the
current distribution.
b. Pam takes a carryover basis in the land equal to $32,000.
c. Pam’s outside basis in the partnership after the distribution is as follows:
Basis in Meddoc $27,000
Plus: Deemed contribution 7,500
Less: Land (32,000)
Remaining basis in Meddoc $2,500
44. [LO 3] {Research} Two years ago, Kimberly became a 30% partner in the KST
Partnership with a contribution of investment land with a $10,000 basis and $16,000 fair
market value. On January 2 of this year, Kimberly has a $15,000 basis in her partnership
interest and none of her pre-contribution gain has been recognized. On January 2,
Kimberly receives an operating distribution of a tract of land (not the contributed land)
with a $12,000 basis and an $18,000 fair market value.
a. What is the amount and character of Kimberly’s recognized gain or loss on the
distribution?
b. What is Kimberly’s remaining basis in KST after the distribution?
c. What is KST’s basis in the land Kimberly contributed after Kimberly receives this
distribution?
10-22
Answer:
a. Kimberly recognizes $3,000 capital gain as a result of the distribution. Under §737,
Kimberly must recognize her pre-contribution gain to the extent that the fair
market value of the distributed property exceeds her partnership interest before the
distribution (but after reduction for any money distributions). Kimberly recognizes
the lesser of her unrecognized pre-contribution gain ($6,000) or the excess of the fair
market value of the distributed land over her pre-distribution outside basis ($3,000;
$18,000 FMV – 15,000 outside basis).
b. If a partner recognizes a pre-contribution gain under §737, the recognized gain
increases the partner’s outside basis. Kimberly’s outside basis in the partnership
after the distribution is as follows:
Basis in KST $15,000
Plus: §737 gain 3,000
Less: Carryover basis in land (12,000)
Remaining basis in KST $6,000
c. KST’s basis in the land that Kimberly originally contributed is $13,000 determined
as follows:
KST basis upon contribution $ 10,000
Plus: Kimberly’s §737 gain 3,000
KST’s basis in land $13,000
Kimberly’s recognized gain under §737 increases the partnership’s basis in the
property that originated the pre-contribution gain.
45. [LO 4] Rufus is a one-quarter partner in the Adventure partnership. On January 1 of the
current year, Adventure distributes $13,000 cash to Rufus in complete liquidation of his
interest. Adventure has only capital assets and no liabilities at the date of the distribution.
Rufus’ basis in his partnership interest is $18,500.
a. What is the amount and character of Rufus’ recognized gain or loss?
b. What is the amount and character of Adventure’s recognized gain or loss?
c. If Rufus’ basis is $10,000 at the distribution date rather than $18,500, what is the
amount and character of Rufus’ recognized gain or loss?
10-23
Answer:
a. Rufus recognizes a capital loss on the distribution of $5,500 representing the
difference between his basis in Adventure of $18,500 and the cash distribution of
$13,000. He must recognize a loss because he receives only cash in the distribution
and the cash is less than his basis in his partnership interest.
b. Adventure does not recognize any gain or loss on the distribution.
c. If Rufus’ outside basis is $10,000 prior to the distribution, he must recognize a
capital gain of $3,000 on the distribution as follows:
Cash distribution $13,000
Less: Basis in Adventure (10,000)
Equals: Gain (capital) $3,000
46. [LO 4] The Taurin Partnership (calendar-year-end) has the following assets as of
December 31 of the current year:
Basis FMV
Cash $ 45,000 $ 45,000
Accounts receivable 15,000 30,000
Inventory 81,000 120,000
Totals $ 141,000 $ 195,000
On December 31, Taurin distributes $15,000 of cash, $10,000 (FMV) of accounts

receivable, and $40,000 (FMV) of inventory to Emma (a 1/3 partner) in termination of
her partnership interest. Emma’s basis in her partnership interest immediately prior to the
distribution is $40,000.
a. What is the amount and character of Emma’s recognized gain or loss on the
distribution?
b. What is Emma’s basis in the distributed assets?
c. If Emma’s basis before the distribution was $55,000 rather than $40,000, what is
Emma’s recognized gain or loss and what is her basis in the distributed assets?
Answer:
a. Emma does not recognize any gain or loss on the distribution.
b. Because Taurin distributes only cash, accounts receivable, and inventory, and the
adjusted bases of the property distributed is greater than her basis in the
partnership, Emma will simply reduce the bases of the hot assets. Emma uses a
three step process to allocate her basis to the distributed property.
1. Emma assigns a basis of $15,000 to the cash, $5,000 to the accounts receivable
and $27,000 to the inventory. Since the sum ($47,000) exceeds her basis in
Taurin, she has a required decrease of $7,000 ($47,000 – 40,000).
10-24
2. Emma allocates the required decrease to the assets with unrealized depreciation.
Since there are no distributed assets with unrealized depreciation, Emma skips
this step.
3. Emma decreases the basis of the assets in proportion to their relative adjusted
bases.
Accounts receivable: Basis allocation = $7,000  ($5,000/$32,000) = $1,094
Inventory: Basis allocation = $7,000  ($27,000/$32,000) = $5,906
After completing the allocation Emma’s basis in the distributed assets are:
Cash $15,000
Accounts receivable ($5,000 - $1,094) 3,906
Inventory ($27,000 - $5,906) 21,094
c. If Emma’s basis in Taurin were $55,000 rather than $40,000, she recognizes a
capital loss on the distribution. Emma calculates her loss of $8,000 as the difference
between her basis in her partnership interest ($55,000) and the sum of the adjusted
bases of the distributed assets ($47,000).
Her basis in the distributed assets is equal to the partnership’s basis in the assets.
Cash $15,000
Accounts receivable 5,000
Inventory 27,000
The carryover bases allow Emma to retain the character of the inherent gains in the
accounts receivable and inventory she receives in the liquidating distribution.
47. [LO 4] Melissa, Nicole, and Ben are equal partners in the Opto partnership (calendar
year-end). Melissa decides she wants to exit the partnership and receives a proportionate
distribution to liquidate her partnership interest on January 1. The partnership has no
liabilities and holds the following assets as of January 1:
Basis FMV
Cash $ 18,000 $ 18,000
Land 30,000 36,000
Totals $ 55,500 $ 90,000
Melissa receives one-third of each of the partnership assets. She has a basis in her
partnership interest of $25,000.
a. What is the amount and character of any recognized gain or loss to Melissa?
b. What is Melissa’s basis in the distributed assets?
10-25
c. What are the tax implications (amount and character of gain or loss and basis of assets)
to Melissa if her outside basis is $11,000 rather than $25,000?
d. What is the amount and character of any recognized gain or loss from the distribution
to Opto?
Answer:
a. Melissa does not recognize any gain or loss on the distribution. Rather, she will
adjust the basis of the distributed assets.
b. Melissa uses a three step process to determine her basis in the distributed property.
1. Melissa assigns a basis of $6,000 to the cash, $-0- to the accounts receivable,
$2,500 to the stock investment, and $10,000 to the land. The sum ($18,500) of the
inside basis is less than her outside basis so she will need to allocate the excess
basis to the basis in the distributed assets other than §751(a) property. Melissa
has a remaining basis of $6,500 to allocate ($25,000 - $18,500) among the
distributed capital assets.
2. Melissa allocates the required increase to the capital assets with unrealized
appreciation to the extent of the appreciation. Melissa allocates $1,500 ($4,000
{1/3 x $12,000} - $2,500 {1/3 x $7,500}) to the stock investment and $2,000
($12,000 {1/3 x $36,000} - $10,000 {1/3 x $10,000}) to the land to bring the bases
of these assets to their fair market value. This leaves $3,000 remaining to be
allocated.
3. Melissa increases the basis of the capital assets in proportion to their relative fair
market values.
Stock investment: Basis allocation = $3,000  ($4,000/$16,000) = $750
Land: Basis allocation = $3,000  ($12,000/$16,000) = $2,250
After completing the allocation Melissa’s basis in the distributed assets are:
Cash $6,000
Accounts receivable -0-
Stock investment ($2,500 + $1,500 + $750) 4,750
Land ($10,000 + $2,000 + $2,250) 14,250
c. If Melissa’s basis in Opto were $11,000 rather than $25,000, she will need to
decrease the basis in the stock investment and land she receives in liquidation of her
partnership interest. She will calculate her basis in the distributed assets as follows:
10-26
1. First she assigns a carryover basis to the distributed assets.

Cash $6,000
Stock investment 2,500
Land 10,000
Since the sum of the adjusted bases of the distributed assets ($18,500) is greater
than her basis in Opto ($11,000), she has a required decrease of $7,500.
2. Melissa allocates her required decrease to the other property with unrealized
depreciation. Since none of the distributed assets have any unrealized
depreciation, Melissa skips this step.
3. In the final step, Melissa allocates the required decrease to the capital assets in
proportion to their adjusted bases.
Stock investment: Basis allocation = $7,500  ($2,500/$12,500) = $1,500
Land: Basis allocation = $7,500  ($10,000/$12,500) = $6,000
After completing the allocation Melissa’s basis in the distributed assets are:
Cash $6,000
Stock investment ($2,500 - $1,500) 1,000
Land ($10,000 - $6,000) 4,000
d. Opto does not recognize any gain or loss on the liquidating distribution.
48. [LO 4] AJ is a 30% partner in the Trane partnership, a calendar year end entity. On
January 1, AJ has an outside basis in his interest in Trane of $73,000, which includes his
share of the $50,000 of partnership liabilities. Trane generates $42,000 of income during
the year and does not make any changes to its liabilities. On December 31, Trane makes a
proportionate distribution of the following assets to AJ to terminate his partnership
interest:
Basis FMV
Inventory $ 55,000 $ 65,000
Land 30,000 25,000
Totals $ 85,000 $90,000
a. What are the tax consequences (gain or loss, basis adjustments) of the distribution to
Trane?
b. What is the amount and character of any recognized gain or loss to AJ?
c. What is AJ’s basis in the distributed assets?
10-27
d. If AJ sells the inventory four years after the distribution for $70,000, what is the
amount and character of his recognized gain or loss?
Answer:
a. Trane does not recognize any gain or loss on the distribution. The liquidation is of a
30% partner and as such does not trigger a technical termination of the
partnership. Trane’s basis in its remaining property is unaffected by the
distribution since there is no §754 election in effect.
b. First, AJ must determine his basis in Trane as of the distribution. At the beginning
of the year, his basis is $73,000. Trane earns $42,000 during the period of which
30% is allocable to AJ. He increases his basis by his $12,600 ($42,000  30%) share
of Trane’s income. Thus, as of the distribution, AJ’s basis in Trane is $85,600
($73,000 + $12,600). Next, AJ accounts for the deemed cash distribution relating to
his reduction of Trane debt. His 30% share of Trane’s $50,000 debt is $15,000. AJ
reduces his outside basis by the $15,000 leaving a basis of $70,600 to allocate to the
distributed assets. He does not recognize any gain or loss on the distribution because
the deemed cash distribution does not exceed his basis in Trane.
c. AJ calculates his basis in the distributed assets as follows:
1. First he assigns a carryover basis to the distributed assets.
Inventory $55,000
Land 30,000
than his basis in Trane after the deemed cash distribution ($70,600), he has a
required decrease of $14,400.
2. AJ allocates his required decrease to the other property with unrealized
depreciation. Since the distributed land has an inherent loss of $5,000, AJ
allocates this amount of the required decrease to the land. Thus at the end of this
step, the basis in the land is $25,000.
3. In the final step, AJ allocates the remaining required decrease $9,400 ($14,400 -
$5,000) to the land. After completing the allocation his basis in the distributed
assets are:
Inventory $55,000
Land 15,600
d. AJ calculates the gain or loss on the subsequent sale of inventory as
Amount realized $70,000
Less: Adjusted basis (55,000)
Equals: Gain on sale of inventory $15,000
The gain is an ordinary gain under §735(a)(2) because AJ sells the inventory within
five years of the distribution.
10-28
49. [LO 4] David’s basis in the Jimsoo Partnership is $53,000. In a proportionate liquidating
distribution, David receives cash of $7,000 and two capital assets: land one with a fair
market value of $20,000 and a basis to Jimsoo of $16,000 and land two with a fair market
value of $10,000 and a basis to Jimsoo of $16,000. Jimsoo has no liabilities.
a. How much gain or loss will David recognize on the distribution? What is the character
of any recognized gain or loss?
b. What is David’s basis in the distributed assets?
c. If the two parcels of land had been inventory to Jimsoo, what are the tax consequences
to David (amount and character of gain or loss and basis in distributed assets)?
Answer:
a. David does not recognize any gain or loss on the distribution.
b. Since Jimsoo’s basis of the distributed assets is less than David’s outside basis and
David receives other property in the distribution, David must adjust the basis of the
land in order to defer his loss. He follows a three step process to adjust the bases:
1. David assigns a basis of $7,000 to the cash, $16,000 to the first parcel of land,
and $16,000 to the second parcel of land. The sum ($39,000) of the bases is less
than David’s basis in Jimsoo so he will need to allocate the excess outside basis to
the basis in the distributed assets. David has a remaining outside basis of
$14,000 (required increase) to allocate ($53,000 - $39,000) among the two parcels
of land.
2. David allocates the required increase to the land with unrealized appreciation to
the extent of the appreciation. David therefore increases the basis of the first
parcel land by $4,000 to $20,000. This leaves $10,000 remaining to be allocated.
3. David increases the basis of the two parcels of land in proportion to their relative
fair market values.
Land 1: Basis allocation = $10,000  ($20,000/$30,000) = $6,667
Land 2: Basis allocation = $10,000  ($10,000/$30,000) = $3,333
After completing the allocation David’s bases in the distributed assets are:
Cash $7,000
Land 1 ($16,000 + $4,000 + $6,667) 26,667
Land 2 ($16,000 + $3,333) 19,333
c. If the land were inventory to Jimsoo, David would not be allowed to increase the
basis of the distributed land. Instead, David would recognize a capital loss of
$14,000 on the distribution. David would have a basis of $16,000 in each parcel of
land (carryover basis).
10-29
50. [LO 4] Megan and Matthew are equal partners in the J & J partnership (calendar-year-end
entity). On January 1 of the current year, they decide to liquidate the partnership.
Megan’s basis in her partnership interest is $100,000 and Matthew’s is $35,000. The two
partners receive identical distributions with each receiving the following assets:
Basis FMV
Cash $ 30,000 $ 30,000
Inventory 5,000 6,000
Land 500 1,000
Totals $ 35,500 $37,000
a. What is the amount and character of Megan’s recognized gain or loss?
b. What is Megan’s basis in the distributed assets?
c. What is the amount and character of Matthew’s recognized gain or loss?
d. What is Matthew’s basis in the distributed assets?
Answer:
a. Megan does not recognize any gain or loss on the distribution although she realizes a
loss on the distribution.
b. Megan uses a three step process to determine her basis in the distributed property.
1. Megan assigns a carryover basis of $30,000 to the cash, $5,000 to the inventory,
and $500 to the land. The sum ($35,500) of the basis is less than her basis in J &
J so she will need to allocate the excess basis to the basis in the distributed assets
other than §751(a) property (i.e., the land). Megan has a remaining basis of
$64,500 to allocate ($100,000 - $35,500) among the cold assets.
2. Megan allocates the required increase to the cold assets with unrealized
appreciation to the extent of the appreciation. Therefore, Megan increases the
basis of the land by $500 to$1,000. This leaves $64,000 remaining to be allocated.
3. Since Megan only receives one cold asset in the distribution, all of the required
increase must increase the basis of the land. Megan increases the basis of the
land by the remaining $64,000 required increase.
After completing the allocation, Megan’s bases in the distributed assets are:
Cash $30,000
Inventory 5,000
Land 65,000
10-30
The application of these rules demonstrates the sometimes strange results from
the allocation process. In this case Megan now has a parcel of land with a basis
of $65,000 even though its fair market value is only $1,000. When she sells the
land, she will recognize a capital loss equal to the difference between the sale
price and her extremely large basis.
c. Matthew does not recognize any gain or loss on the distribution although he realizes
a gain on the distribution.
d. Matthew defers his gain through a basis decrease to the land he receives in
liquidation of his partnership interest. He calculates his basis in the distributed
assets as follows:
Cash $30,000
Inventory 5,000
Land 500
than his basis in J & J ($35,000), Matthew has a required decrease of $500.
2. Matthew allocates his required decrease to the cold assets property with
unrealized depreciation. Since none of the distributed assets have unrealized
depreciation, Matthew skips this step.
3. In the final step, Matthew allocates the entire $500 required decrease to the land.
After completing the allocation, Matthew’s bases in the distributed assets are:
Cash $30,000
Inventory 5,000
Land -0-
51. [LO 4] Bryce’s basis in the Markit Partnership is $58,000. In a proportionate liquidating
distribution, Bryce receives the following assets:
Basis FMV
Cash $8,000 $8,000
Land A 20,000 45,000
Land B 20,000 25,000
a. How much gain or loss will Bryce recognize on the distribution? What is the character
of any recognized gain or loss?
b. What is Bryce’s basis in the distributed assets?
10-31
Answer:
a. Bryce does not recognize any gain or loss on the distribution.
b. Since Markit’s basis of the distributed assets is less than Bryce’s outside basis and
Bryce receives other property in the distribution, Bryce must adjust the basis of the
land in order to defer his loss. He follows a three step process to adjust the bases.
1. Bryce assigns a basis of $8,000 to the cash, $20,000 to land A, and $20,000 to
land B. The sum ($48,000) of the bases is less than Bryce’s basis in Markit so he
will need to allocate the excess outside basis to the basis in the distributed assets.
Bryce has a remaining outside basis of $10,000 (required increase) to allocate
($58,000 - $48,000) among the two parcels of land.
2. Bryce allocates the required increase to the land with unrealized appreciation to
the extent of the appreciation. The combined appreciation in the two parcels of
land is $30,000 ($25,000 for land A and $5,000 for land B). This exceeds Bryce’s
required increase ($10,000). Therefore in this step Bryce must allocate the
required increase to the two parcels of land based on their relative appreciation.
Land A: Basis allocation = $10,000  ($25,000/$30,000) = $ 8,333
Land B: Basis allocation = $10,000  ($5,000/$30,000) = $ 1,667
3. All of Bryce’s outside basis has been allocated in Step 2, so he does not need to
use Step 3 of the allocation process. After completing the allocation Bryce’s
bases in the distributed assets are:
Land A $ 28,333
Land B $ 21,667
52. [LO 1, 5] {Planning} Bella Partnership is an equal partnership in which each of the
partners has a basis in his partnership interest of $10,000. Bella reports the following
balance sheet:
Assets: Basis FMV

Inventory $ 20,000 $ 30,000
Land 10,000 15,000
Totals $ 30,000 $ 45,000
Capital – Toby 10,000
– Kaelin 10,000
– Andrew 10,000
Totals $ 30,000
a. Identify the “hot assets” if Toby decides to sell his partnership interest. Are these assets
“hot” for purposes of distributions?
b. If Bella distributes the land to Toby in complete liquidation of his partnership interest,
what tax issues should be considered?
10-32
Answer:
a. Hot assets under §751(a) for purposes of sales or exchanges of partnership interests
include unrealized receivables and inventory items. Bella’s hot assets include the
inventory with a basis of $20,000 and fair market value of $30,000. For purposes of
distributions, §751(b) defines hot assets as substantially appreciated inventory and
unrealized receivables. Inventory is considered substantially appreciated if its fair
market value exceeds its basis by more than 120%. The value of Bella’s inventory
does exceed its basis by more than 120% (100  $30,000/$20,000 = 150%) and is thus
considered hot asset for purposes of distributions.
b. If Bella distributes the land to Toby in complete liquidation of his partnership
interest, the distribution would be a disproportionate distribution because Toby
receives more than his share of the cold assets. In this case, Toby would be treated
as having sold his share of hot assets to Bella in exchange for cold assets. The
deemed sale would generate ordinary income to Toby.
53. [LO 1, 6] Michelle pays $120,000 cash for Brittany’s one-third interest in the Westlake
Partnership. Just prior to the sale, Brittany’s interest in Westlake is $96,000. Westlake
reports the following balance sheet:
Assets: Basis FMV

Cash $ 96,000 $ 96,000
Land 192,000 264,000
Totals $ 288,000 $ 360,000

Capital – Amy 96,000
– Brittany 96,000
– Ben 96,000
Totals $ 288,000
a. What is the amount and character of Brittany’s recognized gain or loss on the sale?
b. What is Michelle’s basis in her partnership interest? What is Michelle’s inside basis?
c. If Westlake were to sell the land for $264,000 shortly after the sale of Brittany’s
partnership interest, how much gain or loss would the partnership recognize?
d. How much gain or loss would Michelle recognize?
e. Suppose Westlake has a §754 election in place. What is Michelle’s special basis
adjustment? How much gain or loss would Michelle recognize on a subsequent sale of
the land in this situation?
10-33
Answer:
a. Amount realized:
Cash $ 120,000
Brittany’s realized and recognized gain $ 24,000
Brittany’s gain will be capital because Westlake has no hot assets.

b. Michelle has an outside basis in her interest in Westlake equal to her $120,000 cash
payment. Michelle steps into Brittany’s shoes and takes an inside basis of $96,000.
c. Westlake would realize and recognize the following on the sale of the land:
Amount realized $ 264,000
Less: adjusted basis in land (192,000)
Westlake’s realized and recognized gain $ 72,000
d. Michelle would recognize a one-third share of the partnership gain on the sale of the
land: 1/3  $72,000 = $24,000. Because a §754 election was not in effect, Michelle
must recognize her full share of the gain on the sale of the land despite having paid
fair value for her interest in the partnership. Her basis will increase when she
recognizes the gain and only when she sells her Westlake interest will she recognize
an offsetting loss.
e Michelle’s special basis adjustment is the difference between her outside basis and
inside basis in Westlake and is calculated as follows:
Initial interest in Westlake $ 120,000
Minus: Michelle’s inside basis 96,000
Special basis adjustment $ 24,000
The entire special basis adjustment relates to the appreciated land. Michelle would
not recognize any gain on the subsequent sale of the land if Westlake has a §754
election in effect when she purchased her interest.
54. [LO 4, 6] Cliff’s basis in his Aero partnership interest is $11,000. Cliff receives a
distribution of $22,000 cash from Aero in complete liquidation of his interest. Aero is an
equal partnership with the following balance sheet:
Assets: Basis FMV

Cash $ 22,000 $ 22,000
Investment 8,800 8,800
Land 2,200 35,200
Totals $ 33,000 $ 66,000
10-34

Capital – Chris 11,000
– Cliff 11,000
– Cooper 11,000
Totals $ 33,000
a. What is the amount and character of Cliff’s recognized gain or loss? What is the effect
on the partnership assets?
b. If Aero has a §754 election in place, what is the amount of the special basis
adjustment?
Answer:
a. Cliff receives only money in the distribution and the amount exceeds his outside
basis, so Cliff will recognize a capital gain on the liquidation of $11,000. Aero does
not recognize any gain or loss and the distribution does not affect Aero’s basis in its
assets.
b. If Aero has a §754 election in effect at the time of the distribution, Aero will have a
special basis adjustment. The adjustment will be $11,000 basis increase since Cliff
recognized a gain on the liquidating distribution.
55. [LO 4, 6] Erin’s basis in her Kiybron partnership interest is $3,300. Erin receives a
distribution of $2,200 cash from Kiybron in complete liquidation of her interest. Kiybron
is an equal partnership with the following balance sheet:
Assets: Basis FMV

Cash $ 2,200 $ 2,200
Stock (investment) 1,100 2,200
Land 6,600 2,200
Totals $ 9,900 $ 6,600

Capital – Erin 3,300
– Carl 3,300
– Grace 3,300
Totals $ 9,900
a. What is the amount and character of Erin’s recognized gain or loss? What is the effect
on the partnership assets?
b. If Kiybron has a §754 election in place, what is the amount of the special basis
adjustment?
10-35
Answer:
a. Erin receives only money in the distribution and the amount is less than her outside
basis, so Erin will recognize a capital loss on the liquidation of $1,100. Kiybron does
not recognize any gain or loss and the distribution does not affect Kiybron’s basis in
its assets.
b. If Kiybron has a §754 election in effect at the time of the distribution, Kiybron will
have a special basis adjustment. The adjustment will be $1,100 and will be a basis
decrease because Erin recognized a loss on the liquidating distribution.
56. [LO 4, 6] Helen’s basis in Haywood partnership is $270,000. Haywood distributes all the
land to Helen in complete liquidation of her partnership interest. The partnership reports
the following balance sheet just before the distribution:
Assets: Basis FMV

Cash $ 220,000 $ 220,000
Stock (investment) 480,000 220,000
Land 110,000 220,000
Totals $ 810,000 $ 660,000

Capital – Charles $ 270,000
– Esther 270,000
– Helen 270,000
Totals $ 810,000
a. What is the amount and character of Helen’s recognized gain or loss? What is the
effect on the partnership assets?
b. If Haywood has a §754 election in place, what is the amount of the special basis
adjustment?
Answer:
a. Helen does not recognize any gain or loss on the distribution. Instead, she will
simply adjust the basis in the distributed property to defer recognition of any gain
or loss. Helen increases the basis in the land to $270,000. Haywood does not
recognize any gain or loss and the distribution does not affect Haywood’s basis in its
assets.
b. If Haywood has a §754 election in effect at the time of the distribution, Haywood
will have a special basis adjustment. The adjustment will equal $160,000 and will be
a basis decrease because the basis of the property distributed to Helen was
increased.
10-36
Comprehensive Problems
57. [LO 2, 3, 4] Simon is a 30% partner in the SBD partnership, a calendar-year-end entity.
As of the end of this year, Simon has an outside basis in his interest in SBD of $188,000,
which includes his share of the $60,000 of partnership liabilities. On December 31, SBD
makes a proportionate distribution of the following assets to Simon:
Basis FMV
Cash $ 40,000 $40,000
Inventory 55,000 65,000
Land 30,000 45,000
Totals $ 125,000 $150,000
a. What are the tax consequences (amount and character of recognized gain or loss, basis
in distributed assets) of the distribution to Simon if the distribution is an operating
distribution?
b. What are the tax consequences (amount and character of recognized gain or loss, basis
in distributed assets) of the distribution to Simon if the distribution is a liquidating
distribution?
c. Compare and contrast the results from parts a. and b.
Answer:
a. This distribution falls in the category of operating distributions that include
property other than money. As such, Simon must allocate his outside basis to the
distributed assets. First, Simon assigns basis ($40,000) to the money distributed.
Next, he assigns basis equal to the inside basis ($55,000) of the inventory (hot asset).
Finally, Simon assigns basis to the distributed land equal to the inside basis
($30,000). Simon does not recognize any gain or loss on the distribution because the
cash distribution does not exceed his basis in SBD. His remaining outside basis is:
Pre-distribution outside basis $ 188,000
Less: Distributions
Cash $ (40,000)
Inventory (55,000)
Land (30,000) (125,000)
Post-distribution outside basis $ 63,000
10-37
b. Simon does not recognize a gain or loss if the distribution is a liquidating

distribution. To determine the asset bases, Simon must first determine his allocable
basis by considering the deemed cash distribution from the reduction of his debt:
Pre-distribution basis $ 188,000
Debt relief (18,000)
Allocable basis $ 170,000
Simon calculates his basis in the distributed assets as follows:
Cash $40,000
Inventory $55,000
Land 30,000
Since the sum of the adjusted bases of the distributed assets ($125,000) is less
than his basis in SBD after the deemed cash distribution ($170,000), he has a
required increase of $45,000.
2. Simon allocates his required increase to the other property with unrealized
appreciation. Since the distributed land has unrealized appreciation of $15,000,
Simon allocates this amount of the required increase to the land. Thus at the end
of this step, the basis in the land is $45,000.
3. In the final step, Simon allocates the remaining required increase $30,000
($45,000 - $15,000) to the land. After completing the allocation Simon’s bases in
the distributed assets are:
Cash $40,000
Inventory 55,000
Land ($30,000 + $15,000 + $30,000) 75,000
c. Similar to the operating distribution result, Simon does not recognize a gain or loss
if the distribution is a liquidating distribution. The determination of the bases of the
distributed assets differs however between the operating and liquidating
distributions:
Operating Distribution Liquidating Distribution
Inventory $ 55,000 $ 55,000
Land 30,000 75,000
Simon’s basis in the inventory remains the same for both types of distributions
because the tax rules prohibit any increases to hot assets in order to prevent the
conversion of ordinary gain to capital gain. However, in the liquidating distribution,
Simon must allocate his entire outside basis to the distributed assets resulting in a
substantial increase to the basis of the other assets (land).
10-38
58. [LO 1, 4] {Planning} Paolo is a 50% partner in the Capri partnership and has decided to
terminate his partnership interest. Paolo is considering two options as potential exit
strategies. The first is to sell his partnership interest to the two remaining 25% partners,
Giuseppe and Isabella, for $105,000 cash and the assumption of Paolo’s share of Capri’s
liabilities. Under this option, Giuseppe and Isabella would each pay $52,500 for half of
Paolo’s interest. The second option is to have Capri liquidate his partnership interest with
a proportionate distribution of the partnership assets. Paolo’s basis in his partnership
interest is $110,000, including Paolo’s share of Capri’s liabilities. Capri reports the
following balance sheet as of the termination date:
Assets: Basis FMV

Cash $ 80,000 $ 80,000
Receivables 40,000 40,000
Inventory 50,000 80,000
Land 50,000 60,000
Totals $ 220,000 $ 260,000
Liabilities $ 50,000
Capital – Paolo 85,000
– Giuseppe 42,500
– Isabella 42,500
Totals $ 220,000
a. If Paolo sells his partnership interest to Giuseppe and Isabella for $105,000, what is the
amount and character of Paolo’s recognized gain or loss?
b. Giuseppe and Isabella each have a basis in Capri of $55,000 before any purchase of
Paolo’s interest. What are Giuseppe and Isabella’s basis in their partnership interests
following the purchase of Paolo’s interest?
c. If Capri liquidates Paolo’s partnership interest with a proportionate distribution of the

partnership assets, what is the amount and character of Paolo’s recognized gain or
loss?
d. If Capri liquidates Paolo’s interest, what is Paolo’s basis in the distributed assets?
e. Compare and contrast Paolo’s options for terminating his partnership interest.
10-39
Answer:
a. Amount realized:
Cash $ 105,000
Debt relief 25,000 $130,000
Paolo’s realized and recognized gain $ 20,000
To the extent Paolo realizes any amounts attributable to hot assets, his gain will be
classified as ordinary. If Capri sold its assets for their fair market value at the sale
Tax basis FMV Gain/Loss Paolo’s share
Receivables $40,000 $ 40,000 $ -0- $-0-
Inventory 50,000 80,000 30,000 15,000
$ 30,000 $ 15,000
Total gain $ 20,000
Capital gain $5,000
Paolo recognizes $15,000 of ordinary income and $5,000 capital gain from the sale of
his interest in Capri.
b. Giuseppe and Isabella will increase their bases in Capri by the cost of Paolo’s
interest plus their increase in Capri’s allocable liabilities. Each partner will have an
outside basis in Capri equal to $120,000 ($55,000 original basis + $52,500 additional
investment + $12,500 additional debt).
c. Paolo does not recognize any gain or loss on the distribution. Rather he adjusts the
basis in the distributed assets. See answer d.
d. Paolo decreases the basis in the cold assets he receives in liquidation of his
partnership interest. Paolo first reduces his basis for the deemed cash distribution
relating to his reduction in Capri debt ($25,000) leaving an outside basis of $85,000
($110,000 - $25,000). He determines his basis in the distributed assets as follows:
1. He assigns a carryover basis to the distributed assets.
Cash $ 40,000
Receivables 20,000
Inventory 25,000
Land 25,000
than his basis in Capri ($85,000), Paolo has a required decrease of $25,000.
2. Paolo allocates his required decrease to the cold assets property with unrealized
depreciation. Since none of the distributed assets have unrealized depreciation,
Paolo skips this step.
3. In the final step, Paolo allocates the entire $25,000 required decrease to the land.
10-40
After completing the allocation Paolo’s bases in the distributed assets are:
Cash $40,000
Receivables 20,000
Inventory 25,000
Land -0-
e. Under option 1 (sale of Paolo’s interest in Capri), Paolo must immediately recognize
a gain of $20,000: $15,000 is ordinary income and $5,000 is capital gain. He has no
future tax liability related to the transaction. The capital gain will be taxed at a
maximum of 15%. Assuming Paolo has an ordinary marginal tax rate of 35%, Paolo
would have cash after tax of $99,000 [$105,000 – (15%  $5,000) – (35%  $15,000)]
to invest in other projects as he wishes.
Under option 2 (liquidation of Paolo’s interest), Paolo is able to defer any gain on
the liquidation through a basis reduction in the distributed assets. As he sells the
assets, he will recognize gain or loss. If he holds onto the inventory for more than
five years, Paolo will recognize a capital gain on the sale of the inventory rather than
an ordinary gain. The potential downside is that Paolo only receives $40,000 cash in
the distribution. His other proceeds are in the form of receivables (which bear some
risk of default), inventory, and land. If Paolo were to immediately sell the
distributed assets following the distribution, he would recognize $15,000 of ordinary
income on the sale of the inventory and $30,000 capital gain on the sale of the land.
He may incur additional costs to sell or collect on these assets. This option would
leave Paolo with $95,250 after tax cash as follows:
Tax basis FMV Gain/Loss After-tax Cash
Cash $40,000 $40,000 -0- $40,000
Receivables 20,000 20,000 -0- 20,000
Inventory 25,000 40,000 15,000 9,750
Land -0- 30,000 30,000 25,500
$ 45,000 $ 95,250
Note that under option 2, Paolo’s after tax cash is $3,750 less than under option 1.
This is because Paolo ends up recognizing debt relief of $25,000 through the basis
reduction of the land. The $3,750 represents the tax on the $25,000 debt relief.
59. Carrie D’Lake, Reed A. Green, and Doug A. Divot share a passion for golf and decide to
go into the golf club manufacturing business together. On January 2, 2011, D’Lake,
Green, and Divot form the Slicenhook Partnership, a general partnership. Slicenhook’s
main product will be a perimeter-weighted titanium driver with a patented graphite shaft.
All three partners plan to actively participate in the business. The partners contribute the
following property to form Slicenhook:
10-41
Partner Contribution
Carrie D’Lake Land, FMV $460,000
Basis $460,000, Mortgage $60,000
Reed A. Green $400,000
Doug A. Divot $400,000
Carrie had recently acquired the land with the idea that she would contribute it to the
newly formed partnership. The partners agree to share in profits and losses equally.
Slicenhook elects a calendar year end and the accrual method of accounting.
In addition, Slicenhook borrows $1,500,000 from BigBank at the time the contributions
were made. Slicenhook uses the proceeds from the loan and the cash contributions to
build a state-of-the-art manufacturing facility ($1,200,000), purchase equipment
($600,000), and produce inventory ($400,000). With the remaining cash, Slicenhook
invests $45,000 in the stock of a privately owned graphite research company and retains
$55,000 as working cash.
Slicenhook operates on a just-in-time inventory system so it sells all inventory and

collects all sales immediately. That means that at the end of the year, Slicenhook does
not carry any inventory or accounts receivable balances. During 2011, Slicenhook has
the following operating results:
Sales $ 1,126,000
Cost of goods sold 400,000
Interest income from tax-exempt bonds 900
Qualified dividend income from stock 1,500
Operating expenses 126,000
Depreciation (tax)
§179 on equipment $39,000
Equipment 81,000
Building 24,000 144,000
Interest expense on debt 120,000
The partnership is very successful in its first year. The success allows Slicenhook to use
excess cash from operations to purchase $15,000 of tax-exempt bonds (you can see the
interest income already reflected in the operating results). The partnership also makes a
principal payment on its loan in the amount of $300,000 and a distribution of $100,000 to
each of the partners on December 31, 2011.
10-42
The partnership continues its success in 2012 with the following operating results:
Sales $ 1,200,000
Cost of goods sold 420,000
Interest income from tax-exempt bonds 900
Qualified dividend income from stock 1,500
Operating expenses 132,000
Depreciation (tax)
Equipment 147,000
Building 30,000 177,000
Interest expense on debt 96,000
The operating expenses include a $1,800 trucking fine that one of their drivers incurred
for reckless driving and speeding and meals and entertainment expense of $6,000.
By the end of 2012, Reed has had a falling out with Carrie and Doug and has decided to
leave the partnership. He has located a potential buyer for his partnership interest, Indie
Ruff. Indie has agreed to purchase Reed’s interest in Slicenhook for $730,000 in cash
and the assumption of Reed’s share of Slicenhook’s debt. Carrie and Doug, however, are
not certain that admitting Indie to the partnership is such a good idea. They want at least
to consider having Slicenhook liquidate Reed’s interest on January 1, 2013. As of
January 1, 2013, Slicenhook has the following assets:
Tax Basis FMV

Cash $ 876,800 $ 876,800
Investment - Tax Exempts 15,000 18,000
Investment Stock 45,000 45,000
Equipment - net of depr 333,000 600,000
Building - net of depr 1,146,000 1,440,000
Land 460,000 510,000
Total $ 2,875,800 $ 3,489,800
Carrie and Doug propose that Slicenhook distribute the following to Reed in complete
liquidation of his partnership interest:
10-43
Tax Basis FMV

Cash $ 485,000 $ 485,000
Investment Stock 45,000 45,000
Equipment - net of depr 111,000 200,000
Total $ 641,000 $ 730,000
Slicenhook has not purchased or sold any equipment since its original purchase just after
formation.
a. Determine each partner’s recognized gain or loss upon formation of Slicenhook.
b. What is each partner’s initial tax basis in Slicenhook on January 2, 2011?
c. Prepare Slicenhook’s opening tax basis balance sheet as of January 2, 2011.
d. Using the operating results, what are Slicenhook’s ordinary income and separately
stated items for 2011 and 2012? What amount of Slicenhook’s income for each
period would each of the partner’s receive?
e. What are Carrie’s, Reed’s, and Doug’s bases in their partnership interest at the end of
2011 and 2012?
f. If Reed sells his interest in Slicenhook to Indie Ruff, what is the amount and character
of his recognized gain or loss? What is Indie’s basis in the partnership interest?
g. What is Indie’s inside basis in Slicenhook? What effect would a §754 election have
on Indie’s inside basis?
h. If Slicenhook distributes the assets proposed by Carrie and Doug in complete

liquidation of Reed’s partnership interest, what is the amount and character of Reed’s
recognized gain or loss? What is Reed’s basis in the distributed assets?
i. Compare and contrast Reed’s options for terminating his partnership interest.
10-44
Answer:
a.
D'Lake Green Divot
Recognized gain or loss on $ -0- $ -0- $ -0-
formation of Slicenhook
b.
D'Lake Green Divot
Cash contributed - $400,000 $400,000
Basis in contributed land $460,000
Share of Debt {1/3 x ($60,000
mtg + $1,500,000 loan)} 520,000 520,000 520,000
Debt relief (60,000)
Initial tax basis in Slicenhook 920,000 920,000 920,000
c.
Slicenhook Balance sheet
At Formation (January 2, 2011)
Tax Basis
Cash $ 2,300,000
Land 460,000
Total $ 2,760,000
Liabilities $ 1,560,000
Tax Capital:
Carrie D'Lake 400,000
Reed A. Green 400,000
Doug A. Divot 400,000
Total $ 2,760,000
10-45
d.
Slicenhook Total Each Partner's share
Ordinary Income: 2011 2012 2011 2012
Sales 1,126,000 1,200,000 375,333 400,000
Cost of goods sold (400,000) (420,000) (133,333) (140,000)
Operating expenses (126,000) (124,200) (42,000) (41,400)
Depreciation (105,000) (177,000) (35,000) (59,000)
Interest expense (120,000) (96,000) (40,000) (32,000)
Total ordinary income 375,000 382,800 125,000 127,600
Separately Stated Items:

Qualified dividends 1,500 1,500 500 500
Tax-exempt interest 900 900 300 300
§179 expense (39,000) - (13,000) -
Fines and penalties - (1,800) - (600)
Meals and entertainment - -
Deductible (3,000) (1,000)
Non-deductible (3,000) (1,000)
e.
Outside Basis D'Lake Green Divot
Initial tax basis (incl debt) $ 920,000 $ 920,000 $ 920,000
Ordinary income 125,000 125,000 125,000
Dividends 500 500 500
Tax-exempt interest 300 300 300
§179 expense (13,000) (13,000) (13,000)
Debt changes (100,000) (100,000) (100,000)
Cash distributions (100,000) (100,000) (100,000)
Basis at 12/31/10 $ 832,800 $ 832,800 $ 832,800
Ordinary income 127,600 127,600 127,600
Dividends 500 500 500
Tax-exempt interest 300 300 300
Fines and penalties (600) (600) (600)
M&E (2,000) (2,000) (2,000)
Basis at 12/31/11 958,600 958,600 958,600
f. Amount realized:
Cash $ 730,000
Debt relief ($520,000 - $100,000) 420,000 $ 1,150,000
Reed’s realized and recognized gain $ 191,400
10-46
To the extent Reed realizes any amounts attributable to hot assets, his gain will be
classified as ordinary. If Slicenhook sold its assets for their fair market value at the
sale date, the ordinary gain from depreciation recapture would be as follows:
Tax basis FMV Gain/Loss Reed’s share
Equipment $ 333,000 $ 600,000 $ 267,000 $ 89,000
Total gain $ 191,400
Reed recognizes $89,000 of ordinary income from depreciation recapture on the
equipment and $102,400 capital gain from the sale of his interest in Slicenhook.
Indie will take an outside basis in his Slicenhook interest equal to his cash payment
of $730,000 plus his 1/3 share of Slicenhook’s liabilities of $420,000 for a total of
$1,150,000.
g. Indie’s inside basis is equal to Reed’s inside basis before the sale: $538,600. Indie’s
special basis adjustment would be the difference between his outside basis and
inside basis (both net of liabilities) in Slicenhook and is calculated as follows:
Initial interest in Slicenhook ($1,150,000 - $420,000) $ 730,000
Minus: Indie’s inside basis ($958,600 - $420,000) 538,600
Special basis adjustment $ 191,400
The special basis adjustment relates to the equipment, building and land. If
Slicenhook were to make a §754 election, Indie would be allocated additional
depreciation because of the increased basis. In addition if Slicenhook were to sell the
land, Indie would not recognize any gain if Slicenhook had a §754 election in effect
when he purchased his interest.
h. Reed does not recognize any gain or loss on the distribution. Rather he adjusts the
basis in the distributed assets.
Reed’s outside basis in Slicenhook at the distribution is $958,600, including his
$420,000 share of partnership liabilities. Reed will need to allocate this basis to the
distributed assets. Reed first reduces his basis for the deemed cash distribution
relating to his reduction in Slicenhook debt ($420,000) leaving an outside basis of
$538,600 ($958,600 - $420,000) to allocate to the distributed assets. He determines
his basis in the distributed assets as follows:
1. First, he assigns a carryover basis to the distributed assets.
Cash $ 485,000
Investment 45,000
Equipment 111,000
10-47
than his allocable basis in Slicenhook ($538,600), Reed has a required decrease
of $102,400.1
2. Reed reduces the basis in the cold assets (investment) distributed. Since the
basis of the investments is less than the required decrease, Reed reduces the
investments to a basis of $-0-, a reduction of $45,000. This leaves a remaining
required decrease of $57,400.
3. Finally, Reed allocates the remaining decrease to the equipment to reduce its
basis to $53,600 ($111,000 – 57,400).
After completing the allocation Reed’s bases in the distributed assets are:
Cash $485,000
Investment in stock -0-
Equipment 53,600
i. If Reed sells his interest to Indie, Reed must immediately recognize a gain of
$191,400: $89,000 is ordinary income and $102,400 is capital gain. He has no future
tax liability related to the transaction. The capital gain will be taxed at a maximum
of 15%. Assuming Reed has an ordinary marginal tax rate of 35%, Reed would
have cash after tax of $683,490 [$730,000 – (15%  $102,400) – (35%  $89,000)] to
invest in other projects as he wishes.
Under his other alternative in which Slicenhook distributes cash, stock, and
equipment, Reed is able to defer any gain on the liquidation through a basis
reduction in the distributed assets. However as he sells the assets, he will recognize
gain or loss. If Reed were to immediately sell the distributed assets, he would
recognize a $45,000 capital gain on the investments; and on the sale of the
equipment he would recognize a gain of $146,400 ($200,000 FMV - $53,600 basis) of
which $89,000 will be ordinary income due to depreciation recapture and $57,400
would be §1231 gain. This option would leave Reed with $683,490 after tax cash as
follows:
Tax basis FMV Gain/Loss After-tax Cash
Cash $485,000 $485,000 -0- $485,000
Investment in stock -0- 45,000 45,000 38,250
Equipment 53,600 200,000 146,400 160,240 *
$ 146,400 $ 683,490
*After-tax cash from the sale of the equipment is $160,240 [$200,000 – (15% 
$57,400) – (35%  $89,000)], assuming the §1231 gain is taxed at capital gains rates.
1
Since the basis reduction is not at least $250,000, the distribution does not meet the definition of a “substantial
basis reduction”, which would require a mandatory special basis adjustment.
10-48
Note that under the second alternative, Reed’s after tax cash is the same as under
the sale option. However, Reed may incur additional costs to sell these assets, which
would reduce his after-tax cash.
In addition, under the sale option, Carrie and Doug would have a new partner in
their business. This might work out well if Indie agrees with the existing partners
about how the business should run. Otherwise, this might generate some conflicts
between the partners. The partnership would retain all of its assets under this
option so it would not incur any additional cost to replace the equipment that would
be distributed to Reed under the distribution option. Under the distribution option,
not only might Slicenhook need to replace the distributed equipment but it would be
left with only $391,800 of cash ($876,800 pre-distribution [given in problem] -
$485,000 distribution).
10-49

Dispositions of Partnership Interests and Partnership Distributions Solutions Manual Discussion Questions

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Chapter 10 - Dispositions of Partnership Interests and Partnership Distributions

7. [LO 1] For an accrual-method partnership, are accounts receivable considered unrealized

8. [LO 1] Can a partnership have unrealized receivables if it has no accounts receivable?

13. [LO 2] What distinguishes operating from liquidating distributions?

29. [LO 6] Are special basis adjustments mandatory? If so, when?

Less: Outside basis in JOM (44,000)

c. What is Juan’s basis in the partnership interest?

d. What is the partnership’s basis in the assets following the sale?

c. Juan’s basis in his partnership interest is his cost of $45,000.

c. Outside basis as of January 1: $ 62,000

c. What is MaryLynn’s basis in the partnership interest?

b. Lisa’s share of unrealized receivables is $35,000 ($100,000 unrealized receivables 

Total gain $ 15,000

Basis Fair Market Value

a. What are the “hot assets” (§751(a)) for this sale?

b. What is Marco’s gain or loss on the sale of his partnership interest?

c. What is the character of Marco’s gain or loss?

Tax basis FMV Gain/Loss Mark’s share

Basis Fair Market Value

b. What is the character of Franklin’s gain or loss?

Basis Fair Market Value

b. What is Alix’s basis in her remaining partnership interest?

c. What is Michael’s basis in his partnership interest?

Assets: Basis FMV

Liabilities and capital:

What is the amount and character of Newton’s recognized gain or loss?

Total gain $ 11,667

b. What is Coy’s ending basis in his partnership interest?

d. What is Matt’s basis in the distributed property?

e. What is Matt’s ending basis in his partnership interest?

Partner Outside Basis

On December 31 of the current year, the partnership makes a pro-rata operating

a. What is the amount and character of Justin’s recognized gain or loss?

b. What is Justin’s remaining basis in his partnership interest?

c. What is the amount and character of Lauren’s recognized gain or loss?

d. What is Lauren’s basis in the distributed assets?

e. What is Lauren’s remaining basis in her partnership interest?

e. Lauren’s basis in PJenn following the distribution is $2,000, determined as follows:

Partner Outside Basis

On December 31 of the current year, the partnership makes a pro-rata operating

a. What is the amount and character of Adam’s recognized gain or loss?

b. What is Adam’s remaining basis in his partnership interest?

c. What is the amount and character of Alyssa’s recognized gain or loss?

d. What is Alyssa’s basis in the distributed assets?

e. What is Alyssa’s remaining basis in her partnership interest?

e. Alyssa reduces her basis in Partipilo to $-0- after the distribution.

a. What is the amount and character of Karen’s recognized gain or loss?

b. What is Karen’s basis in the land?

c. What is Karen’s remaining basis in her partnership interest?

a. What is the amount and character of Pam’s recognized gain or loss?

b. What is Pam’s basis in the land?

c. What is Pam’s remaining basis in her partnership interest?

b. What is Kimberly’s remaining basis in KST after the distribution?

a. What is the amount and character of Rufus’ recognized gain or loss?

b. What is the amount and character of Adventure’s recognized gain or loss?

On December 31, Taurin distributes $15,000 of cash, $10,000 (FMV) of accounts

b. What is Emma’s basis in the distributed assets?

b. What is Melissa’s basis in the distributed assets?

1. First she assigns a carryover basis to the distributed assets.

c. What is AJ’s basis in the distributed assets?

b. What is David’s basis in the distributed assets?

a. What is the amount and character of Megan’s recognized gain or loss?

b. What is Megan’s basis in the distributed assets?