When a partner completely withdraws from a partnership, they receive a "liquidating distribution." The tax rules are designed to be largely tax-deferred, meaning you typically don't recognize a gain unless you receive cash in excess of your basis. This section helps you calculate the tax outcome and the basis of any property you receive. You can use the interactive calculator below to see how different distribution scenarios play out based on the official rules.
Distribution Outcome Calculator
Enter the values to see the tax impact. The form is pre-filled with the 'Tag' example from the report.
Calculation Results:
Recognized Gain/Loss: $0
Your New Basis in Property: $19,000
Explanation: No gain is recognized because cash ($5,000) does not exceed your partnership basis ($24,000). Your remaining basis ($19,000) is assigned to the property.
Key Tax Rules & Benefits
Tax Deferral: Gain is recognized ONLY if the cash received exceeds your partnership basis. Receiving property allows you to defer tax on appreciation.
Basis Preservation: Your basis in the partnership interest is transferred to the assets you receive, preserving your tax investment to offset future gains.
Loss Recognition: A capital loss can be recognized if only cash and/or "hot assets" (inventory, unrealized receivables) are received, and your basis is more than the assets' value.
Multiple Asset Allocation
If you receive multiple assets, your basis is allocated in a specific order: first to cash, then to "hot assets," and finally to any other property. The rules get complex, especially when your outside basis differs from the partnership's inside basis in the assets. The process ensures your partnership basis is fully accounted for and "zeroed-out" after the liquidation.
Selling Your Partnership Interest
Selling your partnership interest is treated much like selling a capital asset, such as stock. The gain or loss is the difference between what you receive (the "amount realized") and your adjusted basis. A crucial point is that the amount you realize includes not only cash and property but also any relief from your share of partnership liabilities. This section's calculator helps clarify this important calculation.
Gain/Loss Calculator on Sale
Use this tool to determine the amount realized and your capital gain or loss. The form is pre-filled with the 'Kristi' example.
Calculation Results:
Total Amount Realized: $20,000
Capital Gain/Loss: $8,000
Explanation: The amount realized is the sum of cash received and liability relief. The gain is this total amount less your basis.
Key Tax Rules & Benefits
Capital Gain Treatment: The primary benefit is that your gain is typically a capital gain, which is often taxed at lower rates than ordinary income.
"Hot Asset" Exception: Be aware that any gain attributable to your share of the partnership's "hot assets" (inventory, unrealized receivables) will be re-characterized and taxed as ordinary income.
Retirement/Death: Payments to a retiring partner or a deceased partner's successor are similarly split. Payments for interest in assets are capital gains, while payments measured by partnership income are ordinary income.
Income Allocation
When a sale occurs mid-year, the partnership's income or loss for that year must be allocated pro-rata between the selling and buying partners based on the number of days each was a partner.
The Powerful Section 754 Election
This is one of the most significant tax planning tools in partnership taxation. When a partner buys into a partnership, their purchase price ("outside basis") might be higher than their share of the partnership's basis in its assets ("inside basis"). A Section 754 election allows the partnership to "step-up" the new partner's share of the inside basis. This simulator shows the direct financial benefit of this election by reducing the new partner's taxable gain when assets are sold.
Sec. 743(b) Adjustment Simulator
Adjust the inputs to see how the Sec. 743(b) adjustment works. Pre-filled with the 'Oscar' example.
Adjustment Calculation:
Section 743(b) Basis Adjustment: $200,000
This adjustment increases your personal share of the partnership's asset basis. It does not affect other partners.
Impact on Future Asset Sale:
Let's assume the partnership asset your share pertains to is sold for $500,000 (its fair market value when you bought in). Here's your taxable gain:
Your Taxable Gain WITH Election: $0
Your Taxable Gain WITHOUT Election: $200,000
Visualizing the Benefit
The chart below clearly shows the reduction in taxable gain for the new partner when a Section 754 election is in place for a future asset sale.
This demonstrates how the election prevents the new partner from paying tax on appreciation that occurred before they joined.
