Confused why its ordinary and not capital.
The personal service partnership of Allen, Baker & Carr had the following cash-basis balance sheet at December 31, Year 1:
Adjusted Basis Market
Assets per Books Value
Cash $102,000 $102,000
Unrealized accounts receivable — 420,000
Totals $102,000 $522,000
Liability and Capital
Note payable $ 60,000 $ 60,000
Allen, capital 14,000 154,000
Baker, capital 14,000 154,000
Carr, capital 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, Year 2. In addition, Dole assumed Carr’s share of the partnership’s liability.
What amount of ordinary income should Carr report in his Year 2 income tax return on the sale of his partÂnership interest.
$0
$20,000
$34,000
$140,000
You answered A. The correct answer is D.
When a partner sells his interest in a partnership and he is relieved from his share of partnership liabilities, then the amount realized is the amount of cash received plus his share of liabilities. Carr’s amount realized will be $174,000. Carr’s adjusted basis of $34,000, which also includes his share of the partnership liabilities, is subtracted from the amount realized. This leaves a realized gain of $140,000.
To the extent any of the realized gain is attributable to unrealized receivables or substantially appreciated inventory, there will be gain recognized as ordinary income. In this case, there are unrealized receivables with an adjusted basis of $0 and a fair market value of $420,000. Carr’s share of the $420,000 is $140,000 ($420,000 ÷ 3). Carr will have ordinary income of $140,000.
Amount realized: Cash received $154,000
+ Liability relief ($60,000 Ă· 3) 20,000
= Total amount realized $174,000
Less: Adjusted basis: Carr, capital account $ 14,000
+ Carr’s share of partnership liabilities 20,000
= Carr’s adjusted basis in the partnership (34,000)
Realized gain $140,000
Question #: 1878 Category: 6E4 Transactions Between a Partner and the Partnership
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