What Are Partnership Distributions?
Payment of Cash or Property
Distributions from a partnership occur when a partnership makes a payment of cash or property to its partners based on their ownership interests. There are two types of distributions that a partner may receive from a partnership: a current distribution and a liquidating distribution.
Current Distribution versus Liquidating Distribution
A current distribution is one that does not completely retire the partner's interest in the partnership. This typically takes the form of a draw against income. In other words, a partner may simply decide to withdraw some money from the partnership to pay himself or herself income. A liquidating distribution, by comparison, is one that completely retires the partner's interest in the partnership.
For more information about liquidating distributions, contact an accountant or tax attorney.
How Are Current Distributions Taxed?
Each partner has a unique tax basis in his or her partnership interest. The tax basis for each partner in his or her partnership interest is adjusted throughout the life of the business. Withdrawals decrease a partner's tax basis, while contributions increase it.
Withdrawals Represent Return of Basis
Withdrawals from a partnership are initially treated as a nontaxable return of your partnership investment. Only after you have recovered your entire investment (in other words, after your basis has been reduced to zero) are any further partnership withdrawals taxable to you.
Distribution May Be Taxable Event
The partnership itself never recognizes a gain or loss when it distributes money or property to a partner. However, as stated before, the partner who receives the money may recognize a gain to the extent that the money distributed exceeds the partner's adjusted basis in the partnership immediately before the distribution.
Example(s): Assume John has an adjusted basis of $50,000 in John and Smith Partnership. He receives a current distribution of $60,000 cash from the partnership. Since the $60,000 distribution exceeds John's basis by $10,000, he will have to pay income taxes on $10,000. Because John has recovered his basis in the partnership, his basis in the partnership interest is reduced to zero.
Example(s): Assume Mary has an adjusted basis of $1,400 in DEF Partnership. She receives a current distribution of $1,200 cash from DEF. Mary does not recognize any gain on the transaction, and her basis in the partnership after the distribution is $200.
Loan as Distribution
A distribution from a partnership can also take the form of a loan. Because partnerships are legal entities separate from their owners, a partnership can legally lend money to one of the partners. Loans are not considered income if there is a legal obligation to repay them. The loan will not be taxable to the partner and will not affect his or her tax basis in the partnership. Naturally, however, the loan must comply with the normal requirements. That is, there must exist a written obligation to repay the partnership at a determinable date and at a reasonable rate of interest.
What about Property Distributions?
If the partner receives only property and not cash, he or she recognizes no gain.
Example(s): Assume Jack has an adjusted basis of $1,000 in ABC Partnership. The partnership distributes to him a machine with a fair market value of $1,400 and an adjusted basis of $1,200. Jack does not recognize any gain on the transaction. Jack's basis in the machine is $1,000, and his basis in ABC Partnership after the distribution is zero. See the following section for an explanation of basis.
How Do Distributions Affect Basis?
Changes in Basis
A partner's basis cannot go below zero. Over time, a partner's basis will increase or decrease frequently. In general, a partner's basis in the partnership is increased by:
- Cash and property contributed by him or her
- Any taxable gains the partner recognizes on the transfer of property to the partnership
- Separately and nonseparately stated items of income, including capital gains
- Liabilities the partner assumes and increases in partnership liabilities
A partner's basis in the partnership is decreased by:
- Separately and nonseparately stated items of loss and deduction
- Nondeductible partnership expenses
- Cash withdrawals
- Liabilities of the partner that the partnership assumes
- Adjusted basis of partnership property distributed to the partner
Basis in Property Received
When there is a current distribution of property, the partner's basis in property received is equal to the partnership's adjusted basis in the property immediately before the distribution, limited to the partner's adjusted basis in the partnership. In other words, you assume the same property basis that the partnership had in the property, but this figure can't exceed your own basis in the partnership.
Distributions of both Cash and Property
To complicate matters further, if both money and property are distributed together, the money received reduces the partner's adjusted basis before the property received. These concepts become clear with examples.
Example(s): Ron has an adjusted basis of $1,400 in his partnership. He receives a machine with a fair market value of $1,400 and an adjusted basis of $1,200 from the partnership in a current distribution. Ron's basis in the machine after the distribution is $1,200. His basis in the partnership after the distribution is $200.
Example(s): Kim's basis in her partnership is $1,000. She receives $800 cash and a machine with an adjusted basis of $400 from her partnership. Her basis in the partnership is first reduced to $200 by the cash distribution, and her basis in the machine is limited to $200. Thus, her basis in the partnership after the distribution is zero.
Tip: The partnership tax rules are very complex and include a number of elections that can be made, such as an Internal Revenue Code Section 754 election regarding basis adjustment. For more details, contact your accountant, attorney, or financial planning professional.
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