[Anonymous]

The personal service partnership of Allen, Baker & Carr had the following cash basis balance sheet at December 31 of the current year:

Adjusted basis Market value

ASSETS

Cash $ 102,000 $ 102,000

Unrealized accounts receivable − 420,000

Total $ 102,000 $ 522,000

LIABILITY AND CAPITAL

Note payable 60,000 60,000

Capital accounts:

Allen 14,000 154,000

Baker 14,000 154,000

Carr 14,000 154,000

Totals $ 102,000 $ 522,000

Carr, an equal partner, sold his partnership interest to Dole, an outsider, for $154,000 cash on January 1 of the following year. In addition, Dole assumed Carr’s share of the partnership’s liability.

What amount of ordinary income should Carr report on the following year’s income tax return on the sale of his partnership interest?

a.

$140,000

b.

$20,000

c.

$34,000

d.

$0

Explanation

Choice “a” is correct. Carr should report ordinary income of $140,000.

Rule: An interest in a partnership is generally a capital asset. However, any gain resulting from the sale of a partner’s share of unrealized receivables and/or appreciated inventories is treated as ordinary income

Share of unrealized receivables (420,000 x 1/3) = 140,000

Why is this not capital gain? Could I have just taken the share of unrealized receivables (420K x 1/3) and get the answer without going through the first step?

[2B.CPA]

It would normally be capital gain, but I believe there is a special rule if there are unrealized A/R or appreciated inventories (hot assets) then it is treated as ORD income to the extent of those amounts. You can't skip the first step of calculating the total gain. In this problem, it happens that all 140,000 of unrealized receivables amount is treated as ORD gain, but let's say the total gain was only 50k? Then, only 50k would be ordinary gain, since there are no more gains to even treat as ORD.(Sorry if I confused you more… best i can do.. haha)

[Anonymous]

thank you @2B.CPA!

[LilLambLost]

Can someone please explain why the cash he received wasn't a factor in this problem?

[monikernc]

Because the question is asking only for the amount of ordinary income that will be reported.

FAR 7/25/15 76!
AUD 10/30/15 93
BEC 2/27/16 82
REG 5/23/16 88!
Ninja Book and MCQ and the forum - all the way!!!
and a little thing i like to call, time and effort!
if you want things to change, you have to do something different

[LilLambLost]

monikernc wrote:

Because the question is asking only for the amount of ordinary income that will be reported.

How would the cash be treated? I see that it doesn't belong in ordinary income, but could you explain why, please? That's what I don't understand.

[CPAHOPE]

To prevent tax abuse. Normally, selling partners interest is treated as capital gain but since partnership contains receivable, it needs to be allocated equally among the partners. This is called proportionate distribution. Theres unproportionate distribution which is a complex topic which it doesnt test much thankfully. You should look into this topics.

[CPAHOPE]

Cash is treated as a capital gain.

[CPAHOPE]

My bad, please ignore my post. This is related to sales not distribution. You should look into sales n termination of partnership. The idea is the same, to prevent tax abuse though.

[Author]

Replies