The partnership's inside basis of the property carries over to become the partner's basis, thereby reducing the partner's outside basis by the carryover basis.As with the cash distribution, if the FMV of the property exceeds the partner's outside basis in the partnership, then the partner's interest in the partnership is reduced to 0 and the receiving partner's basis in the distributed property equals his outside basis in the partnership before the distribution.
In a liquidating distribution, the basis of property received by a partner is equal to the basis of the partnership interest minus any money received in the same transaction, so the carryover basis in the property can never be greater than the partner's outside basis in the partnership: Partner's Basis in Property in Liquidating Distribution = Partner's Outside Basis – Money Received If a partner has an outside basis of $100,000 and receives a liquidating distribution of $140,000, then a $40,000 gain would be recognized, but if the $40,000 had been property and the rest cash, then the gain would not be recognized, but the partner's basis in the property would be zero, so taxes would have to be paid on the gain of the property when it is sold: Partner's Basis in Property = $100,000 Outside Basis – $100,000 Cash Received A gain or loss may also be recognized by a partner who contributes property to the partnership that, subsequently, is distributed to another partner within 7 years, in which case, the contributing partner would recognize a gain of the FMV of the property over the partner's original tax basis in the property.
716-2nd, Partnerships—Current and Liquidating Distributions; Death or Retirement of a Partner, provides a detailed discussion of the tax consequences of distributions by partnerships to partners, including those arising from distributions of a partner's share of the results of partnership operations, and other distributions by the partnership that do not result in termination of the distributee's interest in the partnership even though accompanied by a change in the distributee's and remaining partners' shares of capital or profits and losses, whether in money or property—all called current distributions—and distributions of money or property on the withdrawal of a partner whether on death or withdrawal—called liquidating distributions.
When property is distributed to a partner, then the partnership must treat it as a sale at fair market value ().
The partner's capital account is decreased by the FMV of the property distributed.
The inside basis is the partnership's tax basis in the individual assets.
The outside basis is the tax basis of each individual partner's interest in the partnership.
Whether earnings are retained in a partnership or distributed to partners has no affect on the taxation of those earnings, since the partners have to pay tax on the earnings whether they are distributed or not.
Earnings are distributed to each partner's capital account from which distributions are charged against.
The property basis that remains after subtracting the outside basis is taxable as a gain. If distributed property also had a secured liability, then the partner assumes the liability which decreases her share of the partnership's liabilities.
The other partners' share of liabilities is also decreased by the deemed distribution.
The book gain or loss on the constructive sale is apportioned to each of the partners' accounts.