Summary of Partnership Dissolution Case - Paper Example

Earlier, Steven Able, Bernard Bernstine, and Tamarra Charles had requested the advice of Joseph Palko on the termination process of their partnership. The case thus is a ruling in response to this application. Able, Bernstine and Charles are the members of a general partnership called Better Craft Homes. According to the case, Able owns a one-half interest in the business while Bernstine and Charles own a one-quarter interest each. Apparently, the partnership purchases land improves and subdivides it, and then sells the plots to clients. Additionally, it uses the calendar year and the accrual method of accounting.

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Immediately before some proposed transactions, the adjusted basis of the partners in their partnership interests is Able $880,000, Bernstine $440,000, and Charles $440,000 respectively. However, even though Able owns the largest interest in the partnership, he is subject to a low rate of income tax, whereas Bernstine and Charles are subject to a much higher rate. A buyer, Paula Peters has approached the partners with interest in obtaining the assets and assuming the partnerships liabilities.

The members propose that the entity uses $160,000 of its cash to pay its current liabilities and then dissolve. Consequently, it would distribute its assets and liabilities as follows. Able would get the land subject to a mortgage, the plans and blueprints, and $20,000 in cash. On the other hand, Bernstine and Charles would receive one-half of the accounts receivables, one-half of the machinery and $10,000 in cash each. They will retain the money distributed. Nevertheless, they will sell all the assets to Peters who will assume the mortgage. These transactions amount to a disposition of the entire continuing business of the partnership. Therefore, the income tax to Able will be a gain of $170,000, namely, $30,000 capital gain and $140,000 ordinary income. Similarly, Bernstine and Charles will each have $85,000 of gain, namely, $15,000 capital gain and $70,000 ordinary income.

Income the Partnership recognizes following the Dissolution

According to Section 731, a partnership making a liquidating distribution does not recognize any gain or loss. Additionally, it recognizes no gain or loss in conjunction with a payment in cash for a withdrawing partners interest (Brewer & Nandi, 2014). However, it may be required to adjust the basis of its assets as stipulated in Section 751.

Amount and Type of Income or Loss recognized by each Partner

A partner recognizes capital gain or loss following a sale or exchange of interest in a partnership as stipulated in the Code 1.741-1. Similarly, according to Code 1.751-1 paragraph (a), any gain attributable to a members interest in unrealized receivable and significantly appreciated stock items would be treated as ordinary income (Salz, 2007). Note that, the amount of any income or loss to the partner is the variance between the money realized on the sale and his or her adjusted basis in the partnership interest.

From the case study, the income tax to Able will be a gain of $170,000, namely, $30,000 capital gain and $140,000 ordinary income. Similarly, Bernstine and Charles will each have $85,000 of gain, namely, $15,000 capital gain and $70,000 ordinary income. However, this is immediately prior the dissolution. Therefore, after the distribution and the partners have sold their interests to Peters, Ables gain will be $356,000 ($1,100,000-$740,000), namely, $76,000 capital gain and $280,000 ordinary income. Similarly, Bernstine and Charless gains will equal to $10,000 ($400,000-$390,000) each, namely, $2,150 capital gain and $7,850 ordinary income.

Basis in the Distributed Property each Partner receives in the Dissolution

According to Section 732, the sum of the bases of the assets a partner receives in a dissolving distribution must equal the members pre-distribution outside basis, reduced by any money distributed. However, the Code 705 paragraph (b) permits partners to use an alternative method for determining the adjusted basis of a partners interest. Accordingly, the adjusted foundation of the partners interest is equal to his or her proportionate share of the partnerships adjusted basis for the assets, which the partner would be entitled to during the dissolution of the association (Ricketts, Tunnell, Manolakas & CCH Incorporated, 2007).

From the case, Able receives the land subject to the mortgage, the plans and blueprints, and $20,000 in cash. Therefore, his basis in the adjusted property equals $740,000 ($720,000 + $40,000 - $20,000). Note that, Bernstine and Charles have an equal basis in the adjusted assets of the partnership. According to the case, their distribution includes one-half of the accounts receivables, one-half of the machinery and $10,000 in cash each. Consequently, their basis equals $390,000 each. That is $250,000 plus $150,000 less $10,000.

Conclusion

To conclude, when a partnership winds up its affairs several issues arise. First, no gain or loss accrues to the partnership because of its distribution of assets. Second, the partners recognize two types of incomes, namely, capital gain and ordinary income. Accordingly, this gain or loss is the variance between the money realized on the sale of distributed assets and his or her adjusted basis in the partnership interest. Consequently, the partners are liable for federal tax on this income.

References

Brewer, M., & Nandi, A. (2014). Partnership dissolution: how does it affect income, employment and well-being?. ISER WP, 30.

Ricketts, R. C., Tunnell, L., Manolakas, T. G., & CCH Incorporated. (2006). Practical guide to partnerships and LLCs. Chicago, IL: CCH.

Salz, S. (2007). Federal tax compliance guide 2008. Place of publication not identified: Cch Incorporated.