Discussion:Partnership - Technical Termination

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Discussion Forum Index --> Tax Questions --> Partnership - Technical Termination

Neacole (talk|edits) said:

30 August 2007
I am seeking advice on the purchase of a 50% interest in an LLC which files as a partnership with two individual members (99% and 1%). My client (S-Corp) would like to purchase a 49.5% and 0.5% interest for $300,000 ($75,000 cash and an installment note to the two members for $225,000 over three years). The two members K-1 basis in the LLC is approx. $8,000 total.

It appears that this transaction will technically terminate the partnership, cause the original members to recognize capital gain on the sale of their capital interest and then a new partnership would be created with a 50/50 interest. If I'm reading correctly it would basically be an equity shift on the tax returns from old to new allocating the capital accounts between the old members and my client.

My questions are - Is there anything I'm missing or someone can elaborate on? Is there anything special about a technical termination except for the two short years returns? Is there a way to structure this purchase inside the partnership that would be better? What about a 754 and would that 754 just be on the $75,000? Any help or questions would be appreciated.

FTF65 (talk|edits) said:

August 31, 2007
The section 754 election is based on the $300k purchase price. The following list covers many of the considerations you may want to think about with respect to technical terminations:

1. The terminating partnership is required to file a short-year final return for the taxable year ending with and including the date of its termination. Notice 2001-5 provides that the “Final Return” box should be checked while the instructions to Form 1065 indicate that the “Final Return” box should not be checked [note: in my experience, it seems that most practitioners follow the Notice].

2. The new partnership is required to file a return for its taxable year beginning after the date of termination of the terminated partnership. The tax year of the new partnership is determined by reference to its partners under section 706(b)(1)(B). Accordingly, the tax year of the new partnership may not necessarily be the same as that of the old partnership.

3. The new partnership retains the employer identification number of the terminated partnership.

4. 'Depreciation and amortization restart:' (i) the terminated partnership computes depreciation for its final-year return as if the assets were disposed of using appropriate conventions and using the short-year rules of Rev. Proc. 89-15; (ii) the new partnership computes depreciation as if the property transferred from the terminated partnership were newly acquired - the short-year rules of Rev. Proc. 89-15 apply [see also section 168(i)(7)]. In addition, Reg. Sec. 1.197-2(g)(2)(iv)(B) provides that the “step-in-the-shoes“ rule under Reg. Sec. 1.197-2(g)(2)(ii) applies to transfers of section 197 intangibles pursuant to section 708(b)(1)(B) terminations.

5. 'Tax Elections:' tax elections made by the terminated partnership are no longer applicable to the new partnership. The new partnership should consider the following elections (among others): (i) Section 754 election to adjust the basis of partnership assets upon the transfer of partnership interests or upon certain distributions from the partnership; (ii) accounting methods; (iii) inventory methods; (iv) election to amortize organizational expenses under section 709; (v) election to amortize start-up expenditures under section 195; (vi) section 704(c) methods.

Also worth noting: because letter rulings are issued to specific taxpayers and the newly-formed partnership is a new taxpayer, it appears that the new partnership cannot rely on any letter rulings received by the old partnership(?)

6. 'Section 754 Elections:' a valid section 754 election with respect to the terminating transfer may be made by either the terminated partnership or the new partnership. If a section 754 election is beneficial for the incoming partner, and the terminating partnership does not have a section 754 election in effect, it is generally preferable to make the election with the terminating partnership (as opposed to the new partnership) so that the new partnership will not be bound by the section 754 election. This will allow the new partnership the flexibility to determine whether a section 754 election is beneficial with respect to future transactions.

7. 'Section 743(b) adjustments of existing partners:' if an existing partner has a section 743 basis adjustment in property held by a partnership that technically terminates, such partner will continue to have the same basis adjustment with respect to property deemed contributed by the terminated partnership to the new partnership, regardless of whether the new partnership makes a section 754 election.

8. Section 704(b) capital accounts of the partners and the book bases of the assets of the terminated partnership carry over to the new partnership. Accordingly, a technical termination does not create new section 704(c) property.

9. Deemed transfers resulting from a technical termination are ignored in applying the section 707 disguised sale rules.

10. A technical termination does not trigger the application of, or begin new periods with respect to, section 704(c)(1)(B) or section 737.

11. A technical termination does not trigger recapture of investment tax credits claimed by the terminated partnership under the “mere change in form” exception in Reg. Sec. 1.47-3(f).

I am less certain about the following items; accordingly, if they are important to you, support your position with your own research:

12. 'Acceleration of unamortized section 481(a) adjustments:' a taxpayer that ceases to engage in a trade or business or terminates its existence must take the remaining balance of any section 481(a) adjustment relating to that trade or business into account in computing its taxable income in the tax year of cessation (or termination). Additionally, the contribution to a partnership of the assets of a trade or business to which the section 481(a) adjustment relates accelerates the section 481(a) adjustment. In short, it appears that a section 708(b)(1)(B) termination accelerates any unamortized section 481(a) adjustments relating to assets that are deemed transferred.

13. 'Write-off unamortized section 709 organization costs:' if the organization costs are considered an asset of the partnership that can be transferred in the deemed section 721 transaction to a new partnership, the basis of the organization costs would presumably carry over and the new partnership would “step-in-the-shoes” of the old partnership. When a partnership is liquidated, unamortized organization costs may be deducted as a section 165 loss, provided that the partnership previously elected to amortize organization expenditures under section 709(b)(1). It is possible that unamortized section 709 costs may not be considered an asset of the terminated partnership that can be contributed to the new partnership. Such costs would remain with the terminated partnership and, therefore, become worthless and deductible when the terminating partnership liquidates. Accordingly, a position also exists to deduct the unamortized balance of the organization costs on the final return of the terminated partnership.

14. 'Write-off unamortized start-up costs:' again, the question is whether unamortized section 195 costs are assets that may be contributed to the new partnership. If not, they should become worthless and deductible at the time the terminating partnership liquidates. Section 195(b)(2) provides for the deduction of unamortized section 195 costs as a section 165 loss when a “trade or business is completely disposed of by the taxpayer” before the end of the amortization period. It is unclear to what extent the contribution/distribution construct of section 708(b)(1)(B) will be applicable outside of Subchapter K.

JR1 (talk|edits) said:

August 31, 2007
Sure have missed you FTF. What a source of solid and thorough info you are!

Neacole (talk|edits) said:

31 August 2007
FTF65 - Thank you! I really appreciate your help.

FTF65 (talk|edits) said:

August 31, 2007
Thanks JR - although I never really left, I've just been extraordinarily busy.

Nevertheless, I try to "give back" to the Almanac whenever I can...

Joshuaaaaaa (talk|edits) said:

31 August 2007
Is there a problem with doing this as a stepped transaction, like buying 49% and 0.5% now, and the other 0.5% in a year and a day? That would get you out of the technical termination, unless you got an auditor who was having a really bad day.

Neacole (talk|edits) said:

1 September 2007
Joshuaaaaaa - we considered that possibility. Thanks for the input!

FTF65 (talk|edits) said:

September 1, 2007
Joshua: in general, I don't think there is a step-transaction issue - the IRS has issued a number of rulings on this - most I think have been favorable (see, for example, PLR's 9805017, 9529037, 9440017, 8517022).

Depending on the facts, you may also want to consider a bifurcation of the capital and profits interests (i.e., sell less than 50% of capital or profits). For example, you could sell 60% of the profits interests in a partnership and 49% of the capital interests and avoid a technical termination as there was not a transfer of 50% of BOTH capital and profits.

KIMBERLY (talk|edits) said:

19 March 2008

This was an impressive overview of a technical termination. One simple question - When you start the new depreciation lives over, you use the nbv for tax as of the last day of the old pship according to section 723, right? The partnership has a $10 NBV for GAAP, $7 FMV and $8 NBV for TAX on the last day of the old partnership. So, I would start the new asset at $8 with a new 5-year life for tax, correct?

McGladreyTaxGirl (talk|edits) said:

14 October 2008
FTF rocks! Your awesome overview really helped me. Thank you so much for the contibution.

Riley2 (talk|edits) said:

17 October 2008
FTF, thanks for the summary. I never knew that the successor partnership could make the 754 election. Do you have a citation to authority on that?

Montero0203 (talk|edits) said:

6 April 2009

I am seeking advice. I have a client that purchased the remaining shares of a partnership in 2008 which is now a disreagared entity in 2008. The partnership had an asset that it was renting out to customers (i.e. boat). What is the client's basis of the asset for depreciation since the client rented it out during the last quarter of 2008? Do I use the NBV of the asset at the date of termination?

Riley2 (talk|edits) said:

6 April 2009
A portion of the basis will be equal to the adjusted basis of the remaining partner's interest. The remaining basis will be equal to the amount paid to the departing partner.

Caseyboy (talk|edits) said:

17 July 2009
We are preparing a return for a partnership whose members (each 50%) sold 1/2 of their interest to two new members resulting in 4 25% members. I am curious as to how the member interests are reflected relative to ending percent of ownership on the tecnhical termination return and beginning ownership percent on the sucessor return?

RoyDaleOne (talk|edits) said:

17 July 2009
I was thinking 50 and 25.

Buckeye0426 (talk|edits) said:

18 November 2009
Using the above analysis as a back drop for a technical termination, a couple of questions (1) at the time of the technical termination and final tax return, does the balance sheet go away or continue on. I understand that the fixed assets get revalued. (2) When the new partnership starts up, is there a new book basis set up for the capital accounts....in my case, one of the old partners goes away, the second partner takes a reduced interest and a new 3rd party takes over majority interest.

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