19.8 Partnership Termination & Liquidation
Key Takeaways
Technical termination under §708(b)(1)(B) was REPEALED by TCJA for tax years beginning after 12/31/2017 — no longer triggered by 50%+ sale.
Actual termination: No part of any business continues in partnership form.
Sale of partnership interest: capital gain/loss (hot assets §751 may convert portion to ordinary).
Liquidating distribution: cash > basis = gain; cash < basis = loss (only if receiving cash, receivables, or inventory).
Section 754 election adjusts inside basis when partner sells or dies.
Once made, §754 election applies to all future transfers (revocable only with IRS consent).
Why This Matters for the Exam
Termination and liquidation rules are tested, especially the post-TCJA termination rule (which differs from pre-2018 law) and the §754 election.
IMPORTANT — Technical Termination Was REPEALED
The old §708(b)(1)(B) "technical termination" rule — under which a partnership terminated automatically when 50%+ of interests were sold within 12 months — was repealed by the Tax Cuts and Jobs Act (TCJA) for partnership tax years beginning after December 31, 2017. OBBBA did not restore it. For the 2025 testing window:
- A 50%+ sale of interests no longer causes automatic termination.
- The partnership simply continues with new partners, and §743(b) (with a §754 election) adjusts inside basis for the purchasers.
- This is a frequent EA exam trap — older study materials still describe the old rule.
Actual Termination Under Current §708(b)(1)
A partnership terminates only when no part of any business, financial operation, or venture continues to be carried on by any of its partners in a partnership:
| Event | Result |
|---|---|
| No business continues by any partner in partnership form | Termination |
| All but one partner leaves (single-member result) | Termination (becomes disregarded entity or single-member LLC) |
| Wind-up and dissolution | Termination |
| Merger/division | Special rules under §708(b)(2) |
Liquidation: Sale vs. Distribution
| Method | Tax Treatment |
|---|---|
| Sale to third party | Capital gain/loss (hot assets §751 may convert) |
| Liquidating distribution | Generally tax-deferred (gain only if cash > basis) |
Sale of Partnership Interest
| Element | Treatment |
|---|---|
| General | Capital gain/loss |
| Hot assets (§751) | Portion is ordinary income |
| Buyer's basis | Cost basis (outside) |
| Inside basis | Adjusted under §743(b) only if §754 election is in effect (or substantial built-in loss) |
Liquidating Distribution
| Rule | Treatment |
|---|---|
| Cash > basis | Capital gain |
| Cash < basis | Capital loss (only if liquidating partner receives ONLY cash, unrealized receivables, and/or inventory) |
| Property received | Carryover basis (adjusted to extent of remaining outside basis) |
Section 754 Election
When a partner sells an interest or dies, an 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 under §743(b) |
| Mismatch causes problems | Mismatch eliminated for that partner |
§754 Election Rules
| Rule | Detail |
|---|---|
| Who makes it | Partnership |
| How | Statement attached to timely-filed Form 1065 (including extensions) |
| Duration | Permanent for all future §743(b) and §734(b) transfers |
| Revocation | Only with IRS consent |
| Mandatory §743(b) | Required when there is a "substantial built-in loss" (> $250,000) regardless of §754 |
§754 Example
| Scenario | Amount |
|---|---|
| Buyer pays $1,000,000 for the interest | |
| Partnership assets' inside basis (allocable share): $400,000 | |
| Partnership assets' FMV (allocable share): $1,000,000 | |
| Without §754: No additional inside-basis adjustment | |
| With §754: §743(b) adjustment of +$600,000 allocated to the buyer |
§736 Retiring/Deceased Partner Payments (Briefly)
- §736(a) payments — not for partnership property — treated as guaranteed payment or distributive share.
- §736(b) payments — for partnership property — treated as a distribution.
- Rules unchanged by OBBBA.
Real-World Scenario
Scenario: Partner A (25%) and Partner B (30%) each sell their interests during 2025. Total = 55% of capital and profits.
- Pre-2018 result: Would have triggered a §708(b)(1)(B) technical termination.
- Current (post-TCJA, 2025) result: No termination. The partnership simply continues with the two new partners.
- Each selling partner: Recognizes gain/loss on the sale (capital with §751 ordinary carve-out).
- New partners' inside basis: Adjusted under §743(b) only if a §754 election is in effect.
On the Exam
Question types to practice on termination/liquidation:
- Termination Trap Questions: "Does a 50%+ sale trigger termination?" (Answer: NO post-TCJA.)
- Liquidation Questions: "Partner receives $80k cash, has $100k basis. Result?"
- §754 Questions: "What is the benefit of §754 election?"
The key is to remember: No more technical termination. Sale = capital gain (hot assets carve to ordinary). §754 adjusts inside basis to match buyer's cost.
Under current law (post-TCJA, Tax Year 2025), which causes termination of a partnership?
Two partners sell 25% each within 12 months
One partner sells 60% to a new partner
All business operations cease and no business continues in partnership form
A new partner is admitted
Partner with $100,000 basis receives $80,000 cash in liquidation. Tax consequence?
$20,000 capital gain
$20,000 ordinary loss
$20,000 capital loss
No gain or loss
What is the primary benefit of a §754 election?
Selling partner defers gain
Inside basis adjusts to match buyer outside basis
Converts ordinary income to capital gain
Eliminates K-1 filing
Sections you finish are checked off in the contents.