Liquidating Distributions
At the desk
| 736 split | (b) payments for the partner's share of property = distribution, capital gain over basis, no deduction. (a) everything else = ordinary, SE taxable, reduces the other partners' income |
| Service partnership | General partner's payments for receivables and goodwill (no agreement provision) are 736(a) |
| Property basis | Substituted: outside basis less money, to receivables/inventory first, then other property; increase to appreciated assets then by FMV; decrease to declined assets then by basis |
| Loss | Only if money + receivables + inventory and nothing else; = basis – money – partnership basis in those items; capital |
| Still a partner | Until the last payment; K-1 each year; partnership does not terminate |
| Trap | A buyout papered as a 'sale to the LLC' is a liquidating distribution: 736 and 751(b), not 741 |
On this page
- Loss 4 notes · 2 examples
- Basis of Distributed Property 10 notes · 3 examples
- Disposition of Distributed Assets 3 notes
- Order of Payment on Liquidation 1 note
Distributions liquidating the entire interest of a partner may be due to partnership termination and/or the retirement or death of the partner. Sale to the partnership of a partner's entire interest is treated as a liquidating distribution.
- Payments to a retired partner that are determined by partnership income are treated as a distributive share of partnership income, regardless of the period over which they are paid. The income is characterized at the partnership level.
- Payments to a retiring partner in liquidation of an interest that are treated as distributive shares of partnership income or as guaranteed payments (Sec. 736(a)) are ordinary income and subject to self-employment tax. They reduce the remaining partners' income.
- Payments for the partner's interest in partnership property (Sec. 736(b)) are distributions: tax-free to basis, capital gain above it, and not deductible by the partnership, so the remaining partners' distributive shares are not affected.
- added 2026 For a general partner in a partnership where capital is not a material income-producing factor (a service partnership), payments for unrealized receivables and for goodwill are Sec. 736(a) unless the partnership agreement provides for goodwill. For a partnership where capital is material (a real estate LLC, a manufacturer), nearly everything is Sec. 736(b).
- Amounts received from the partnership in liquidation of a partnership interest are generally treated the same as other (nonliquidating) distributions.
- Gain is recognized to the extent money distributed exceeds the liquidating partner's adjusted basis (AB) in the partnership interest immediately before the distribution.
- Decrease of the partner's share of partnership liabilities is treated as a distribution of money.
- The gain is capital gain. However, precontribution gain or disproportionate distribution of substantially appreciated inventory (SAI) or unrealized receivables (URs) could result in ordinary income.
- Inventory is considered substantially appreciated if its FMV exceeds 120% of the partnership's adjusted basis.
- The liquidating partner is treated as a partner for tax purposes until all payments in complete liquidation have been made, and keeps receiving a K-1.
- Gain is recognized to the extent money distributed exceeds the liquidating partner's adjusted basis (AB) in the partnership interest immediately before the distribution.
- Distributions of inventory made in exchange for all or part of a partner's interest in other partnership property are governed by the "substantially appreciated" rule.
- Gain from such distributions are taxed as ordinary income if the fair market value exceeds 120% of the partnership's AB of inventory.
Loss
- A loss is realized when money and the FMV of property distributed are less than the AB of the partnership interest.
- No loss is recognized if any property other than money, unrealized receivables, and inventory is distributed in liquidation of the interest.
- Loss recognized is limited to any excess of the AB in the partnership interest over the sum of money and the AB in the URs and inventory.
- Loss recognized is characterized as if from sale of a capital asset.
Amber has a basis of $17,000. In complete liquidation she receives $11,000 cash and receivables with a zero basis. She reports a $6,000 capital loss ($17,000 – $11,000 – $0), and the receivables have a zero basis in her hands. If she had received a capital asset instead of the receivables, no loss would be allowed and the asset would take a $6,000 basis.
Partner Z has a $100,000 basis and receives $10,000 cash and office equipment worth $80,000 in complete liquidation. No loss is recognized; the $90,000 remaining basis becomes Z's basis in the equipment. My worksheet: Partner basis $100,000; cash $10,000 + equipment $80,000 = $90,000; loss –$10,000 realized, not recognized, absorbed into the equipment.
Basis of Distributed Property
- The partner's basis in the distributed property is the partnership's AB in the property immediately before distribution, but is limited to the distributee's AB in the partnership interest immediately before distribution minus any money received in the distribution. In a liquidation the partner's remaining basis is substituted into the property, up or down (Sec. 732(b)).
- If the total partnership basis of assets distributed exceeds the partner's basis in the partnership interest, allocate the decrease in the same manner as for current distributions: first to assets with a decline in value, to the extent of the decline, then by relative adjusted basis.
- For liquidating distributions only, if the basis in the partnership interest exceeds the total partnership basis of distributed assets, allocate the increase by the following steps:
- Determine the amount of basis to be allocated.
| Item | |
|---|---|
| Beginning basis in the partnership interest | |
| – | Money received |
| – | Partnership basis in unrealized receivables and inventory received |
| = | Basis to allocate to other property |
-
- First, assign the existing partnership basis to each property.
- Allocate any appreciation (FMV over partnership basis) to each asset, to the extent of its appreciation.
- Allocate any remaining basis (Basis to allocate – Appreciation of distributed assets) to the assets based on FMV prior to the distribution.
Ruth has a $72,500 basis and receives, in complete liquidation, an apartment house (partnership basis $10,000, FMV $50,000) and an office building (basis $12,500, FMV $12,500). Assign $10,000 and $12,500; $50,000 remains. The apartment house has $40,000 of appreciation and takes all of it; $10,000 remains, allocated by FMV: $8,000 to the apartment house, $2,000 to the building. Bases: apartment house $58,000, office building $14,500.
Dave has a $60,000 basis and receives $20,000 cash, inventory (partnership basis $15,000), land (basis $24,000, FMV $40,000) and a building (basis $8,000, FMV $10,000). After cash and inventory, $25,000 remains for land and building, which carry $32,000 of partnership basis: a $7,000 decrease. Neither has declined in value, so the decrease is allocated by relative basis: land $5,250, building $1,750. Bases: land $18,750, building $6,250.
Jeff has a $150,000 basis and receives $70,000 cash, inventory (basis $30,000), a building (basis $80,000, FMV $90,000) and a computer (basis $20,000, FMV $10,000). After cash and inventory, $50,000 remains against $100,000 of basis. First the computer absorbs its $10,000 decline; the remaining $40,000 decrease is allocated by the adjusted bases after that step ($80,000 and $10,000): building $35,556, computer $4,444. Bases: building $44,444, computer $5,556.
- The distributee's holding period in the distributed property includes that of the partnership.
- added 2026 Form 7217 is required of the partner for a liquidating distribution that includes property, the same as for a current distribution.
Disposition of Distributed Assets
- Gain on the sale of URs distributed by the partnership is ordinary income, forever.
- Gain or loss realized on inventory distributed depends on the nature of the property in the distributee's hands, but is ordinary if sold within 5 years of the distribution (Sec. 735).
- Depreciation recapture potential in distributed equipment follows the equipment to the partner.
Order of Payment on Liquidation
- My note from the chapter's picture: when a partnership winds up, the assets are sold (gain or loss to the partners), creditors are paid first, including a partner who lent money to the partnership, then the limited partners, then the general partners in their ownership shares. The general partners eat last.
Private reference, not client advice. Original notes written 2022–2023 while studying for the SEE Part 2; figures updated October 2026 (Rev. Proc. 2025-32, Rev. Proc. 2026-15, P.L. 119-21). Verify current-year amounts before relying on them.