IRC 751 "Hot Assets": Calculating and Reporting Ordinary Income in Disposition of Partnership or LLC Interests THURSDAY, JULY 9, 2015, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours . To earn credit you must: • Participate in the program on your own computer connection (no sharing) – if you need to register additional people, please call customer service at 1-800-926- 7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover . • Listen on-line via your computer speakers. • Respond to five prompts during the program plus a single verification code . You will have to write down only the final verification code on the attestation form, which will be emailed to registered attendees. • To earn full credit, you must remain connected for the entire program. WHO TO CONTACT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program : -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.
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IRC 751 "Hot Assets" July 9, 2015 Thomas I. Hausman Yoram Keinan Law Office of Thomas I. Hausman Carter Ledyard & Milburn tomh@thausmanlaw.com Keinan@clm.com Christopher McLoon Verrill Dana cmcloon@verrilldana.com
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
Section 751(a) Current Law Christopher McLoon Verrill Dana, LLP
A Little Background
Aggregate v. Entity: Competing Constructs for Tax Purposes Aggregate - An interest in each Entity - An interest in the Partnership Asset Partnership Per Se • Partner holds a share of each partnership asset • Partner holds an interest in AB as an entity. • • Example: A and B each contribute $100,000 each A sale of the interest is a sale of the interest in the to Partnership AB for a 50% interest in entity - a capital asset. Partnership AB. Partnership AB acquires land for $200,000 and generates $10,000 in a receivable (rent). • In a pure aggregate view, if A sells the 50% interest, A is selling a 50% interest in the land plus a 50% interest in the receivable. 7
Aggregate v. Entity Entity Aggregate • A's Interest is in • A's Interest A A AB assets, not AB as in AB, and AB an entity holds interest in AB assets AB AB Receivable Receivable Real Estate Real Estate 8
Section 751 Compromise • In 1954, Congress enacted Section 751 to prevent taxpayers from using the entity theory to convert into capital gain the value derived from assets producing ordinary income. In other words, Congress adopted the entity theory as to partnership interests, except as to certain assets that generate ordinary income. As to those assets, Congress adopted an aggregate approach. Those assets are: • Unrealized receivables • Appreciated Inventory 9
Unrealized Receivables • Evolving definition – Has always included rights to payment for: • Goods delivered or to be delivered • Services rendered or to be rendered • Amounts not previously included in income under partnership’s method of accounting • Applies only to rights arising from contracts/agreements that exist at time of sale (or distribution) • Basis includes costs or expenses paid or accrued but not previously taken into account under the partnership’s method of accounting 10
Unrealized Receivables • Evolving definition – Other Items Gain from mining property – Section 617(f)(2) Gain from stock in a DISC – Section 992(a) Gain from Section 1245 Property Gain from PFIC Stock – Section 1248 Gain from Section 1250 Property Gain from Farm Recapture Property – §1251(c) Farm Land Gain – Section 1252(a)(2) Gain from Franchises, Trademarks, and Trade Names – Section 1253(a) 11
Inventory Items • Stock in trade of the partnership • Other property properly included in inventory if on hand at the close of the taxable year • Property primarily held for sale to customers in the ordinary course of the partnership’s trade or business 12
Inventory Items • Any other property of the partnership which, on sale or exchange, would be considered property other than a capital asset and other than Section 1231 property • Any property retained by the partnership that, if held by the partner selling his interest or receiving a distribution would be considered property within the definition of inventory items above 13
Example 1 – Basic 751(a) Calculation • A and B are equal partners in personal service partnership PRS. B transfers its interest in PRS to T for $15,000 when PRS’s balance sheet is as follows: • Note: PRS has no 704(c) property and the capital assets are non-depreciable 14
Assets Basis Value Cash $3,000 $3,000 Loans Receivable $10,000 $10,000 Capital Assets $7,000 $5,000 Unrealized Receivables $0 $14,000 Totals $20,000 $32,000 Liabilities & Capital Liabilities $2,000 $2,000 Capital A $9,000 $15,000 B $9,000 $15,000 Totals $20,000 $32,000 15
Example 1 – Basic 751(a) Calculation B’s Gain without Section 751(a) Item Value Comments Amount Realized $16,000 Includes $15,000 of cash plus $1,000 of Section 752 reduced share of liabilities Adjusted Basis $10,000 Includes $9,000 regular basis plus $1,000 share of liabilities Gain $6,000 16
Example 1 - Section 751 Gain Calculation Item Value Comment Amount Realized $14,000 Value of Unrealized Receivables Adjusted Basis $0 Income on Sale of $14,000 Unrealized Receivable B’s 50% share of Income $7,000 The amount of Section from sale of Unrealized 751(a) gain on the sale of Receivable B’s interest 17
Example 1 – Capital Gain/Loss Calculation Item Value Comment Gain from Sale without $6,000 From slide 12 Section 751 Section 751 Gain from Sale $7,000 From slide 13 Capital Gain/(Loss) from ($1,000) Gain from Sale without Sale Section 751 minus the amount of Section 751 Gain 18
Section 743 Adjustment • Assuming that PRS has a Section 754 election in place, T is entitled to a Section 743 adjustment to the inside basis of assets • Adjust for the difference between • transferee’s outside basis (sections 742 and 752, reduced by share of liabilities) • Transferee’s share of inside basis – proceeds of hypothetical liquidation adjusted for gain/loss • Allocated under Section 755 & Treas. Reg. § 1.755-1(b)(2). 19
Post Section 743 Adjustment Balance Sheet Assets Basis 743 Basis Adj. Value Cash $3,000 $3,000 Loans Receivable $10,000 $10,000 Capital Assets $7,000 $5,000 Unrealized Receivables $0 $6,000 $14,000 Totals $20,000 $6,000 $32,000 Liabilities & Capital Liabilities $2,000 $2,000 Capital A $9,000 $15,000 T $15,000 $15,000 Totals $26,000 $32,000 20
Example 1a – Sale at a Discount • A and B are equal partners in personal service partnership PRS. B its interest in PRS to T for $12,000 when PRS’s balance sheet is as follows: • Note: PRS has no section 704(c) property and the capital assets are non-depreciable 21
Assets Basis Value Cash $3,000 $3,000 Loans Receivable $10,000 $10,000 Capital Assets $7,000 $5,000 Unrealized Receivables $0 $14,000 Totals $20,000 $32,000 Liabilities & Capital Liabilities $2,000 $2,000 Capital A $14,000 $15,000 B $4,000 $15,000 Totals $20,000 $32,000 22
Example 1a – Gain Calculation B’s Gain without Section 751(a) Item Value Comments Amount Realized $13,000 Includes $12,000 of cash plus $1,000 of Section 752 reduced share of liabilities Adjusted Basis $10,000 Includes $9,000 regular basis plus $1,000 share of liabilities Gain $3,000 23
Example 1a - Section 751 Gain Calculation Item Value Comment Amount Realized $14,000 Value of Unrealized Receivables Adjusted Basis $0 Income on Sale of $14,000 Unrealized Receivable B’s 50% share of Income $7,000 The amount of Section from sale of Unrealized 751(a) gain on the sale of Receivable B’s interest 24
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