Key Takeaways
- Technical termination: 50%+ interests sold within 12 months.
- Actual termination: No business continues in partnership form.
- Sale of interest: capital gain/loss (hot assets may convert to ordinary).
- Liquidating distribution: cash > basis = gain; cash < basis = loss (if only cash/receivables/inventory).
- Section 754 election adjusts inside basis when partner sells or dies.
- Once made, §754 election applies to all future transfers.
Partnership Termination & Liquidation
Why This Matters for the Exam
Termination and liquidation rules are tested, especially the technical termination and §754 election.
Expect at least 3-4 questions on termination/liquidation.
Technical Termination
Under §708(b)(1)(B), partnership terminates if within 12 months, 50% or more of interests are sold.
| Requirement | Detail |
|---|---|
| Threshold | 50%+ of capital and profits |
| Time period | 12 months |
| Effect | Tax year closes, elections may reset |
Technical Termination Example
| Transaction | Cumulative |
|---|---|
| March: Partner A sells 33% | 33% |
| August: Partner B sells 20% | 53% |
| Result | Technical termination (>50% in 12 months) |
Actual Termination
Partnership actually terminates when:
| Event | Result |
|---|---|
| No business continues | Full termination |
| Only one partner remains | Termination |
Liquidation: Sale vs. Distribution
| Method | Tax Treatment |
|---|---|
| Sale to third party | Capital gain/loss (hot assets may convert) |
| Liquidating distribution | Generally tax-deferred |
Sale of Partnership Interest
| Element | Treatment |
|---|---|
| General | Capital gain/loss |
| Hot assets (§751) | Portion is ordinary income |
| Buyer's basis | Cost basis |
Liquidating Distribution
| Rule | Treatment |
|---|---|
| Cash > basis | Capital gain |
| Cash < basis | Capital loss (if only cash/receivables/inventory) |
| Property received | Carryover basis (adjusted) |
Section 754 Election
When a partner sells or dies, inside/outside basis mismatch may occur.
| Without §754 | With §754 |
|---|---|
| Buyer has cost basis (outside) | Same |
| Partnership keeps old basis (inside) | Partnership adjusts inside basis |
| Mismatch causes problems | Mismatch eliminated |
§754 Election Rules
| Rule | Detail |
|---|---|
| Who makes it | Partnership |
| How | Statement attached to timely return |
| Duration | Permanent for all future transfers |
| Revocation | Only with IRS consent |
§754 Example
| Scenario | Amount |
|---|---|
| Buyer pays $1 million for interest | |
| Partnership assets basis: $400,000 | |
| Partnership assets FMV: $1 million | |
| Without §754: No additional depreciation | |
| With §754: Inside basis stepped up $600,000 |
Real-World Scenario
Scenario: Partner A (25%) and Partner B (30%) each sell their interests in the same year. Total = 55%.
- Technical termination: Yes (55% > 50% within 12 months).
- Effect: Partnership tax year closes, may need to restart elections.
- Partners: Each recognizes gain/loss on their sale.
On the Exam
Expect 3-4 questions on termination/liquidation, typically:
- Technical Termination Questions: "Which causes technical termination?"
- Liquidation Questions: "Partner receives $80k cash, has $100k basis. Result?"
- §754 Questions: "What is the benefit of §754 election?"
The key is to remember: 50% sold in 12 months = technical termination. Sale = capital gain (hot assets = ordinary). §754 adjusts inside basis to match buyer's cost.
Which causes a technical termination under §708?
Partner with $100,000 basis receives $80,000 cash in liquidation. Tax consequence?
What is the primary benefit of a §754 election?