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- Technical termination under §708(b)(1)(B) was REPEALED by TCJA for tax years beginning after 12/31/2017 — no longer triggered by 50%+ sale.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.
Expect at least 3-4 questions on termination/liquidation.
IMPORTANT — Technical Termination Was REPEALED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rule — under which a partnership terminated automatically when 50%+ of interests were sold within 12 months — was repealed by the Tax Cuts and Jobs Act (TCJA) for partnership tax years beginning after December 31, 2017.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
Expect 3-4 questions on termination/liquidation, typically:
- 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?
Partner with $100,000 basis receives $80,000 cash in liquidation. Tax consequence?
What is the primary benefit of a §754 election?