Category: Estate & Gift; Sales & Exchanges; Partnerships
Subject: Gift of Limited Partnership Interest
Title: Various Issues
IRC Sections: 1001, 1041
Filename: 1266.html
Date Produced: 09/95

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Background
Taxpayer, TP, owns an interest in a limited partnership, LP. Under the partnership agreement and the rules of Section 752, partnership debt is allocated to TP's partnership interest. TP's capital account in LP is negative. TP plans to gift 50% of his interest.

Issues
1. For purposes of preparing TP's K-1, should his negative capital account be reduced by half and transferred to the new partner?

2. Will income be triggered by the gift?

3. If instead of a gift, TP transferred 50% of his partnership interest pursuant to a divorce, would the transfer trigger gain?

Answers
1. I do not think there is a definitive answer to this question. The tax law does not per se dictate the K-1 presentation. I personally think it better to transfer half the negative capital to the new partner thereby leaving the donor's capital account consistent with his tax basis.

2. Gain is definitely triggered under the part-gift, part-sale rules.

3. Transfer incident to a divorce will not trigger gain.

Discussion: Issue One
This aspect of capital accounting for purposes of a partner's K-1 is not directly controlled by the tax law. The instructions to Form 1065 do not speak to this issue. You are aware, of course, that capital accounts per the K-1 are frequently "out-of-synch" with interest basis. This result is unavoidable here.

It seems to me that one has to make a practical choice as to which partner's capital account will be inconsistent with his outside basis.

-TP clearly loses 50% of his basis as a result of this transaction. Accordingly, reducing his K-1 capital account by half achieves consistency with outside basis, but leaves the new partner's capital account inconsistent with outside basis.

-The new partner's basis is the greater of the amount paid for the interest (i.e., the debt assumed) or carryover of the old partner's basis. Regulation Section 1.,1015-4(a). In this case, the amount paid is greater and thus controls. In order to get the new partner's basis to synchronize with his capital account, it would be necessary to leave all the negative capital with the old partner, but that would destroy consistency for the old partner.

I personally feel strongly that the new partner should have the consistency problem, not the old. Partners who buy out other partners almost always have an outside-inside basis discrepancy: this is a common and expected occurrence. Also, it is the new partner, not the old partner, whose basis discrepancy would get "repaired" should the partnership make a Section 754 election.

Discussion: Issue Two
There is no question that gain is recognized because the assumption of debt by the new partner is treated as sale proceeds to TP. This transaction is split into two parts, a sale part and a gift part. This is called the part-gift, part-sale rule.

TP recognizes gain equal to the amount of debt assumed by the new partner as against 50% of his interest basis. When we discussed this matter by phone, I said that basis must be allocated between the gift and the sale. That statement is true for part-gift, part-sale transactions with a charity, but not here. Simply 50% of TP's basis would be offset against the sale proceeds. See Regulation Sections 1.1001-1(e), 1.1015-4(a), and 1.1015-4(e). Incidentally, the charitable contribution allocation rules are found at Regulation Section 1.1011-2.

Discussion: Issue Three
Section 1041 provides that no gain or loss shall be recognized on transfers of property between spouses or between former spouses if incident to a divorce. The transfer is treated instead as a gift. The issue here is whether consideration in the form of debt relief is protected. Debt relief or any other consideration clearly is protected under Section 1041. The Committee Reports on P.L. 98-369 (Deficit Reduction Act of 1984) provide in part as follows.

This nonrecognition rule applies whether the transfer is for the relinquishment of marital rights, for cash or other property, for the assumption of liabilities in excess of basis, or for other consideration and is intended to apply to any indebtedness which is discharged. [Emphasis added.]

In addition, Temporary Regulation Section §1.1041-1T, Q-12 provides as follows.

-Q-12. Do the rules described in A-10 and A-11 apply even if the transferred property is subject to liabilities which exceed the adjusted basis of the property?

- A-12. Yes. For example, assume A owns property having a fair market value of $10,000 and an adjusted basis of $1,000. In contemplation of making a transfer of this property incident to a divorce from B, A borrows $5,000 from a bank, using the property as security for the borrowing. A then transfers the property to B and B assumes, or takes the property subject to, the liability to pay the $5,000 debt. Under section 1041, A recognizes no gain or loss upon the transfer of the property, and the adjusted basis of the property in the hands of B is $1,000.