19.8 Partnership Termination & Liquidation
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.
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?