Sale of a Partnership Interest

The sale of a partnership interest generally results in a capital gain or loss (Sec. 741). The gain or loss is the difference between the amount realized and the adjusted basis of the partnership interest.

Amount Realized and Basis

• The amount realized includes the relief of any liabilities that have been assumed by the buyer (Sec. 752(d)). A partner who sells for “nothing” and is relieved of a $10,000 debt share has a $10,000 amount realized.

• The basis of the partnership interest must be adjusted for the current year’s distributive share and other allocations through the date of sale (Sec. 706(c)(2)). The property the partner originally contributed is not a factor; only the running basis is.
• The partnership may make an election for an optional adjustment to the basis of partnership assets in the year the interest is transferred (Sec. 754).
  • The adjustment is the difference between the transferee partner’s basis for the partnership interest and the proportionate share of the basis of all partnership property. See the Sec. 754 election page.
• The sale may be made to an outside party or another partner. A sale to the partnership is treated as a liquidating distribution.
• Note that a sale of a partnership interest relates to a partner’s outside, or adjusted, basis. Inside basis relates to the basis the partnership has in its assets and can be affected by some elections by either the partner or partnership.
• updated 2026 An exchange of one limited partnership interest for another is not a like-kind exchange; since 2018, Sec. 1031 applies only to real property.
• added 2026 A gifted interest sold by the donee takes the donor’s basis and holding period; the donee’s gain is long-term if the donor’s holding period plus the donee’s exceeds a year.

Unrealized Receivables

• If a partner receives money or property in exchange for any part of a partnership interest, the amount due to his or her share of the partnership’s unrealized receivables or inventory items results in ordinary income or loss (Sec. 751(a)).
  • added 2026 On a sale, all inventory counts, appreciated or not; the 120% test applies only to distributions.
  • Unrealized receivables include cash-basis receivables and the Sec. 1245 and Sec. 1250 recapture the partnership would recognize on a sale of its assets.
  • added 2026 The ordinary portion can exceed the total gain, leaving a capital loss on the remainder.

• Gain attributable to unrealized receivables or inventory is ordinary income.
• added 2026 The partnership must file Form 8308 for any sale or exchange of an interest involving Sec. 751 property and furnish the statement (Part IV, the seller’s Sec. 751 figures) to the transferor and transferee by January 31 of the year after the sale. The IRS has granted penalty relief on the Part IV timing for 2023, 2024 and 2025 transfers while the form is phased in. check Verify whether the relief was extended to 2026 transfers before relying on it.
• added 2026 Within the capital gain, the partner looks through to the partnership’s assets for unrecaptured Sec. 1250 gain (25%) and collectibles gain (28%).
• added 2026 Installment reporting is available for the Sec. 741 portion; the recapture portion of the Sec. 751 gain is recognized in the year of sale (Sec. 453(i)).

Termination of Partnership

• A partnership terminates for federal tax purposes only when operations of the partnership cease, i.e., no part of any business, financial operation or venture continues to be carried on by any of its partners in a partnership.
  • updated 2026 The “technical termination” on a sale of 50% or more of the interests within 12 months was repealed for tax years beginning after 2017. My notes still described the old rule; a sale of interests, even all of them to one buyer, no longer terminates the partnership unless the business stops or only one owner is left.
  • added 2026 A two-member LLC that buys out one member becomes a disregarded entity on that date (Rev. Rul. 99-6); the 1065 for the year is a final short-period return.
• The tax year of a partnership closes with respect to a partner whose entire interest in the partnership terminates by death, liquidation, or other means.
  • A deceased partner’s allocable share of partnership items up to the date of death will be taxed to the decedent on his or her final return.
  • Any items allocated after the date of death will be the responsibility of the successor in interest.
  • The partner’s self-employment income includes the partner’s distributive share of income earned by the partnership through the end of the month in which the partner’s death occurs.
  • added 2026 A partnership does not terminate on the death of a partner; it continues while the estate or successor shares in profits, and terminates when the surviving partner is the only owner left or the business stops.
• A return must be filed for the short period through the date of termination.
• The conversion from a partnership to an LLC (limited liability company) is not considered a sale, exchange, or liquidation of any partnership interest.
  • The partnership’s tax year does not close, and the LLC can continue to use the partnership’s taxpayer identification number.
• added 2026 The conversion of a partnership to an S corporation (by electing on Form 8832 and Form 2553, or by merging into a corporation) is a deemed contribution of assets to a corporation followed by a liquidation of the partnership (Rev. Rul. 84-111). Each partner’s share of liabilities is a deemed distribution on the conversion date; a partner with negative tax capital recognizes gain.

A partner who leaves by having the partnership buy the interest back, rather than selling to a buyer, is on the next page: liquidating distributions.

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.