Category: Partnerships &
LLCs; Sales & Exchanges Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Taxpayer C, a corporation, is the sole general partner of Taxpayer A. Taxpayer C has a large negative capital account. Issues 2. Does the distribution cause Taxpayer C to recapture its negative capital account? Answers 2. Nothing about the distribution per se causes Taxpayer C to recapture its negative capital. Care should be taken that nothing in the distribution causes Taxpayer C's share of partnership debt to fall to a level sufficient to require recapture. Discussion Reg. Section 1.708-1(b)(1)(ii) provides in part that a disposition of a partnership interest by liquidation of the interest does not constitute a sale or exchange for purposes of Section 708(b)(1)(B). Based on this regulation, the distribution of Taxpayer B units is not counted for purposes of determining whether interests in Taxpayer A aggregating to 50% or more of partnership capital or profits has been sold or exchanged within a 12-month period. It is important to note that while the distribution of Taxpayer B units in liquidation of certain Taxpayer A limited partners is not a sale or exchange with respect to Taxpayer A, the distribution does count as a sale or exchange of the Taxpayer B units. See Section 761(e)(1). Accordingly, if Taxpayer A, as a 50% partner (unit-holder) of Taxpayer B, completely liquidated, the liquidating distribution would terminate Taxpayer B. As I understand it, Taxpayer A does not contemplate total liquidation. However, it is important to note that Taxpayer A's distribution of Taxpayer B units could aggregate with other changes in Taxpayer B's ownership, changes that could occur out of your sight, to terminate Taxpayer B. I suggest that it might be advisable both from a professional liability standpoint as well as a matter of courtesy to Taxpayer B to put everyone on notice of this possibility. Finally, there is the matter of Taxpayer C's negative capital account. It seems to me there is nothing in the distribution of Taxpayer B units that would directly trigger Taxpayer C's negative capital account. I would assume that Taxpayer C is relying on a share of debt from Taxpayer A to support its negative capital account. I would assume that most or all of this debt flows through from Taxpayer B. Presumably, when Taxpayer B units are distributed to Taxpayer A limited partners, the total amount of debt flowing through to Taxpayer A will be reduced considerably. I would not expect a net reduction in Taxpayer C's debt share to result from this: I suspect that the amount of debt associated with the retiring limited partners is already allocated to them as things stand now. In other words, any Taxpayer B debt flowing to Taxpayer A that is associated with the Taxpayer B units distributed to the LP's is already allocated to the LP's as things stand now. Accordingly, distribution of those units does not reduce Taxpayer C's share of debt. If on the other hand, any debt associated with Taxpayer B units to be distributed is now being allocated to Taxpayer C, the Taxpayer C will likely suffer a net reduction in its overall debt-share. Of course, this could bring about a recapture of Taxpayer C's negative capital account. Of course, I am unable to help with the debt allocation issue in the absence of sufficient facts to evaluate the situation. Should you desire my help in this regard, I would be happy to assist you in any way you desire.
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