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Evette Davis: Welcome to today's webinar, "Sale of Partnership Interest." We're glad you joined us today.

My name is Evette Davis, and I am a stakeholder liaison with the Internal Revenue Service.

And I will be your moderator for today's webinar, which is slated for 75 minutes.

Before we begin, if there is anyone in the audience that is with the media, please send an e-mail to the address on the slide.

Be sure to include your contact information and the news publication you're with.

Our Media Relations and Stakeholder Liaison staff will assist you and answer any questions you may have.

As a reminder, this webinar will be recorded and posted to the IRS Video Portal in a few weeks.

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If you're having trouble hearing the audio through your computer speakers, please click the closed captioning drop-down arrow located on the left side of your screen.

This feature will be available throughout the webinar.

During the presentation, we'll take a few breaks to share knowledge-based questions with you.

At those times, a polling-style feature will pop up on your screen with a question and multiple-choice answers.

Select the response you believe is correct by clicking on the radio button next to your selection and then clicking Submit.

Some people might not get the polling question, and this may be because you have your pop-up blocker on.

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Type your question in the text box and click Send.

This is very important, folks.

Do not enter any sensitive or taxpayer-specific information.

Again, welcome, and thank you for joining us for today's webinar.

Before we move along with our section, let me make sure you are in the right place.

Today our Large Business and International Division will share information related to the Sale of partnership interest.

This webinar is scheduled for approximately 75 minutes.

Now I'd like to introduce you to today's speakers.

Michael Halpert is a senior manager in LB&I's Pass-Through Entities Practice Area, over its Tax Shelter Promoter program and Campaign Development team.

The Campaign Development team evaluates campaigns involving pass-through entities and was instrumental in getting the Sale of Partnership Interest campaign approved and out to the field.

Andrew Dux and Geoff Gaukroger are Senior Revenue Agents in our Large Business and International Division.

Andrew has a Master's in Professional Accountancy and is a Subject-Matter expert, co-leading the Sale of Partnership Interest campaign for the last two years.

Geoff has a Master's in Accounting and is a Subject-Matter Expert in the Partnership and TEFRA Practice Network.

I'm going to turn it over to Mike to get us started.


Michael Halpert: Thank you, Evette.

And welcome, everybody, to IRS's Pass-Through Entities introductory webinar through the IRS portal.

Today's presentation is a technical discussion on the sale of a partnership interest.

Again, as Evette mentioned, my name is Michael Halpert, I am a Senior Manager with the Pass-Through Entities area.

Before getting into a technical discussion, just a few words about IRS, LB&I, and PTE.

I realize I'm throwing around acronyms now, but it will make more sense shortly.

There are four primary civil enforcement divisions within IRS.

They are the Small Business/Self-Employed, Wage and Investment, Tax-Exempt and Government Entities, and Large Business and International, also known as LB&I.

Today's presentation is sponsored by LB&I and the Pass-Through Entities area.

This next slide may resemble a seeing-eye chart, but it is actually the LB&I's organizational structure.

LB&I has three, what is called, geographic practice areas.

These are shown at the very bottom.

And agents assigned domestic income-tax examinations are assigned in these areas.

Other parts of the LB&I structure include International Operations.

And PTE, again, or Pass-Through Entities, is another area.

This is shown at the bottom, second rectangle on the left.

Parts of PTE conducts income-tax examinations, while another part provides technical assistance to our examiners with complex pass-through entity issues.

It's members from this part of PTE that are making the presentation today.

And LB&I generally audits taxpayers with $10 million or more in assets.

If you have followed the tax news, you probably heard of the term "campaign." To work more effectively, LB&I developed a means of identifying significant compliance risks, or issues, and then identifying taxpayers with, potentially, those characteristics.

This is done through sophisticated data analysis, filtering, and screening.

Not every campaign involves audits.

Other treatment streams include, for example, taxpayer and practitioner outreach, like we're doing here; IRS form changes; and what is called soft letters.

Where campaigns involve examinations, they often include agent training, technical assistance, and feedback.

We just talked about campaigns.

And this slide shows a partial listing of active campaign.

LB&I has a total of 53 approved and active campaigns, with about an equal split between domestic and international issues.

The link at the bottom of the screen here takes you to a list of all of the active LB&I campaigns.

As mentioned, this webinar focuses on one of LB&I's campaigns -- the sale of a partnership interest.

This is often a very complicated issue that is not addressed correctly.

Today we will not only explain the law but also share the Service's position on common issues encountered during income-tax examinations.

As Evette mentioned, your presenters today are Andrew Dux and Geoff Gaukroger.

Andrew and Geoff are subject-matter experts with PTE.

Both have been with the Service for more than 13 years.

And both are currently assisting agents on this very issue.

Geoff, I'll pass the microphone to you.

Geoff Gaukroger: Alright. Thanks, Mike.

Okay, as you start the task, we just wanted to throw out, this isn't going to be the same old stale partnership-interest class that maybe you've taken before.

We think you're going to hear some new things you haven't heard elsewhere.

We know that you've all heard of the tax law, but what Andrew and I are going to talk about is, over the course of the last couple of years, we've gotten our eyes on hundreds of tax returns across the nation prepared by CPA firms of all sizes.

And we've seen how the firms are reporting concerning sale of partnership interest and how they've applied Section 751.

What else is going to be new, we're going to dive into this important concept of valuation, when you prepare the hypothetical sale for Section 751.

And we know valuations are subjective topics.

However we plan to bring a straightforward approach that the Service has been employing in these examinations.

So there are five ways that a partner may dispose of a partnership interest, which are listed here -- sales, exchange, gift, death, or abandonment.

But for today's call, we're going to limit our discussion to just sales of partnership interest.

If you've taken a sale of partnership interest class before, you've most likely seen a slide like this, that brings out the two major theories underlying partnership taxation -- the entity theory and the aggregate theory.

Entity theory is the concept that most of us are more familiar with.

It's where the business is a distinct and separate entity from its owners.

Whereas the aggregate theory, this is more complex.

This is what we are going to dig into today.

Section 751 has, as its base, aggregate theory.

Again, the entity theory, this is where the business is separate and distinct.

For example, partnership units or LLC units, they can be purchased and sold to transfer ownership of the entity.

And the entity on its own makes selections and has methods of accounting separate from its partners.

Whereas aggregate theory -- this is what we really hope you can take away from the class today -- under aggregate theory, the business operations are considered an aggregate of the individual co-owners.

The co-owners have bound themselves together with the intention of sharing gains and losses.

So, under the aggregate theory, each partner is treated as the owner of an interest in the partnership's assets, liabilities, and operations.

For example, if you have two 50/50 partners, each partner is considered an owner of all the assets and liabilities, with each having a 50% ownership interest in each item held by the partnership.

Okay, to get started, let's look at how to compute a gain or loss.

A partner who sells the partnership interest must recognize gain or loss on the sale.

The total gain or loss is the difference between the sales proceeds received less the partner's basis in interest.

Although this is a concept that most all accountants would know, sales proceeds minus basis equals gain.

Let's not go too fast here.

Let's focus on each of these three.

The first one, sales proceeds, those items are listed on this slide.

For example, $50,000 in cash received, in this example.

Second item -- basis.

This is computed by scheduling out the partner's interaction with the partnership since inception.

You start with the partner's initial contribution to the entity and then adjust each year based on the K-1 for income, loss, and changes in debt.

It is actually pretty straightforward.

Okay, the last item, the gain.

Here, in our example, we computed a $40,000 gain.

It's just a gain and we're done, and that's it?

No. That's the focus of this class, is to understand how this $40,000 gain will be taxed.

The gain may be bifurcated into components, and parts taxed at different tax rates.

And so you may ask, "Why?" Well, it's because of the aggregate theory.

Evette Davis: Geoff?

Geoff Gaukroger: We have to look at -- Yes? Evette Davis: Sorry about that.

This is Evette. I'm sorry.

Is there any way you could speak up or turn your speaker up a little bit more?

We've got some folks saying that they can't hear you very well.

I do apologize for the interruption.

Geoff Gaukroger: No problem.

Yeah, I'm doing the best I can here.

Hopefully, this will help. Evette Davis: [ Chuckles ] Geoff Gaukroger: [ Speaking indistinctly ] Here in our example, we computed a gain of $40,000.

Is that the gain and we're done?

No, the focus here is to understand how the $40,000 gain will be taxed.

The gain may be bifurcated into components, and parts will be taxed at different tax rates.

That's why.

Because of this aggregate theory, where we have to look inside the entity.

In Entity theory, we would discover this outside the entity.

Here, we're looking inside the assets held by the partnership.

And if this $40,000 gain has Section 751 assets within it, then we'd have to bifurcate our gain into different components.

Okay, next slide.

This slide states, the gain or loss on the sale of partnership interest results in capital gain.

Well, that's the simple entity theory concept, and that is the general rule.

And it is possible that that will be the answer.

But the tax law requires us to employ aggregate theory here and look within the partnership and the assets.

So, if the entity holds a certain type of asset, which our Section 751 assets, then a portion of the gain or loss on the sale of the partnership must be treated as ordinary instead of capital.

This ordinary gain or loss is then subtracted from the total gain or loss, and the remaining is capital.

And just to note, it's possible for a partner to actually recognize ordinary gains and a capital loss on the sale of a partnership interest.

The remainder of this class will be about defining what the Section 751 assets are and how the computation is done in order to determine the amount of the ordinary portion.

I also want to mention a second complexity.

We stated, the ordinary portion of the gain on the sale will be subtracted from the total gain.

However, not all capital gains are taxed at the same rate.

So, capital gains from collectibles are taxed at a maximum rate of 28%.

Unrecaptured Section 1250 gains are captured at a rate of 25%, while all other capital gains are taxed at a maximum rate of 20%.

We just want to mention here that this 20% capital gain rate is not taking into account additional 3.8% tax related to the net investment income tax which applies in some situations.

Anyway, my point here, with step one, we are bifurcating the total gain on the sale of a partnership interest, between it's ordinary and capital portion.

Once we get the capital portion, we're also going to bifurcate the capital gain, possibly, into components.

Again, this is all done based on the aggregate theory.

If I've confused you at all, hang in there.

This is the extent of the new stuff we're going to go over and teach today.

The rest of the class is just to go over it again and explain it in more detail and provide examples.

At that, let's pause here and have our first polling question.

Evette Davis: You've got it, Geoff.

Great job.

I know this is some good information.

And we want to make sure everyone hears you.

Audience, let's go to our first polling question.

And that question is, "What code section requires a partner to report ordinary gain if the partnership owns assets that generate ordinary income at the time the partner sells his interest?

Is it, "A," Section 61; "B," Section 731; "C," Section 741; or, "D," Section 751?

I know Geoff just explained in detail some information about this.

So, hopefully, you will get this correct.

And we're going to give just a moment.

Click on that radio button that best answers this question, folks.

And going to give you just a few more seconds to make your selection.

And we'll start the countdown to end the polling in 5...4...3...2...1.

Okay, we're going to stop the polling now.

And let's share the correct answer on the next slide.

And the correct answer is, "D," Section 751.

Now let's see what percentage of you got that correct.

Let's see.

Looks like 85% of you answered correctly.

That's actually pretty good.

Geoff, what do you think?

Geoff Gaukroger: I think that's pretty good.

Evette Davis: Alright, take it away.

Geoff Gaukroger: Okay.

Now let's look at an example.

Partner "C" sold his 40% interest in a partnership to a new partner for $19,000 in cash.

Partner C's share of the partnership liability at the time of the sale was $2,000.

Therefore, the amount realized upon the sale was $21,000.

This is composed of the $19,000 in cash received and the $2,000 in liabilities relieved.

Partner "C"'s basis was $3,506 at the time of the sale.

Therefore, Partner "C" would recognize a gain of $17,494 on the sale of the partnership interest.

Okay, this question is all set up for the more difficult aspects of applying 751 that is coming up.

And we'll continue to use this same example as we move through the remainder of the course.

So let's make sure everyone understands this example as the foundation for the upcoming concepts so no one gets lost.

Okay, so this is a continuation of the previous slide, with a few additional facts.

We will look at the character of the partner's gain from the sale transaction.

Looking at some of these facts, we see Partner "C" would report $2,665 of ordinary gain under Section 751, and the remaining $14,829 as capital gain.

Where did the 751 gain come from?

Is it additional gain? No.

Like we said in prior slides, we're going to bifurcate the gain into components.

They're going to be taxed at different rates.

On slide, information is provided.

It said $6,663 of 751 gain is record entity.

Where did that come from?

That's where we're headed.

Okay, next slide.

We introduced the gains from the sale of partnership interest.

Then, we ran into the Section 751 thing, which applies due to the aggregate theory.

Question is, "What is that?" We're going to continue with the numeric example I just went over.

However, we want to pause and go on a tangent for a moment to discuss Section 751.

Okay, as listed on the slide, Section 751 assets include two categories -- unrealized receivables and inventory.

We're going to go into detail on each one of these on the next slide.

Okay, unrealized receivables.

The definition of "unrealized receivables" is composed of three subcomponents: goods delivered or to be delivered; second bullet, services, same as number one but post-service businesses; and lastly, bullet number three.

Although the wording of this is not completely clear on the face of it, for practical purposes, this is the item that creates all the Section 751 in the majority of the cases.

So, real quick, just to explain what this sentence is saying.

If the company were to sell all of its assets, including its depreciable fixed assets, would any of those items result in ordinary treatment?

Basically, you're taking your complete fixed-asset register, selling every asset at its fair market value, through the Form 4797, and any and all depreciation recapture, where the fair market value is greater than the tax net book value/ This would result in ordinary income treatment, and thus those fall under Section 751.

Since depreciable assets are such a big deal, we want to begin to emphasize it.

We've had a lot of practitioners tell us that their entity didn't have 751, or 751 doesn't apply to their case because there is no depreciation to capture in the underlying assets.

However, in reality, that's almost impossible in most cases.

A company with hundreds to thousands of assets that is being depreciated at an accelerated rate, it is very unlikely the fair market value of these assets is exactly equal to the tax net book value for each and every asset.

Although this concept of Section 751 is a more complicated topic and is often overlooked or not dealt with correctly, the sale of partnership interest is a very common transaction.

So practitioners need to be aware of the correct 751 treatment for their clients.

But, first, Evette, looks like we're ready for our second question.

Evette Davis: You've got it, Geoff.

And I am ready.

And, hopefully, audience, you're ready, too.

So, here is our second polling question.

"What assets are often the most common types of unrealized receivables?

Is it: "A," inventory; "B," amortizable and depreciable assets; "C," accounts receivable; or is it, "D," land?

Okay, think about what Geoff just told us.

Take a moment and click on the radio button that you believe best answers this question.

I'll just give you a few more seconds to think about it.

And remember what Geoff just talked about.

And we'll close the polling in 5...4...3...2...1.

Alright let's stop the polling now and share the correct answer on the next slide.

Alright, folks, then the correct response is "B," amortizable and depreciable assets.

Now let's see how many of you responded correctly.

Okay, looks like 67% responded correctly.

You said it was going to get a little tough, Geoff.

Can you give us a little bit more detail and explain why the answer is "B," amortizable and depreciable assets, sir?

Geoff Gaukroger: Okay, no problem.

We're going to go over all this again.

So, the aggregate theory is looking within the entity to see if every asset -- if this had been an asset sale, is there any embedded ordinary income in the entity.

We know, under entity theory, if we sold the LLC units, we would just have a capital gain.

We need to look into the entity and do the deeds or hypothetical asset sales.

And what occurs is that the item, of all items that a partnership would own, is a fixed asset.

So amortize the depreciable assets or what would lead to the most common type of ordinary income treatment.

That is because of accelerated depreciation, Section 179.

The fair market value being in sale is greater than the asset value.

But don't worry, we're going to go into more detail on this again.

Alright, thanks for that. We'll move on here.

Evette Davis: Move on into 2.0.

Geoff Gaukroger: Now that we've explained what unrealized receivables are, we want to discuss the other 751 category, which is inventory.

And the goal of 751 is to prevent a partner from being able to avoid ordinary income treatment on certain items by putting it into a partnership.

And those items may have appreciated or embedded ordinary gain in them.

So, what we've noticed, nowadays with just-in-time inventory and companies having high turnover of their inventory, you don't see inventory as often as falling into this substantially appreciated category.

In most cases, we just aren't seeing it.

But it can exist.

For example, a land developer who has developed properties for sale and is holding these lots of inventory, it is very common that those could go up in value over the years.

And so you would have to do a deem sell of those lots at their current fair market value if certain partners claims interest during the year.

Okay, next slide.

This one misc. issues for these purposes we want to be comprehensive and mention these items.

But due to time limits, we want to focus on some but we are not able to go into detail on these.

But real quick, a partner can report the failed partnership interest under Section 453, which is the installment method.

However, if there's any 751 ordinary gain, that cannot be reported on the installment method.

It has to be reported on the year of sale.

Second item, when a partner sells a partnership interest, this disposition will impact previously suspended losses under the passive at-risk rules and Section 163(j).

Third one, we just wanted to mention here there are special rules under 707(b)

which discuss related party sales, where a gain has to be treated as ordinary instead of capital.

The last one, as preparers note that Form 8308 must be included in the partnership tax return when an entity holds 751 property and a partner has sold their interest during the year.

Okay, another one, kind of quick, here.

Although we're primarily discussing sale of partnership interest issues relating to the seller of their interest, we wanted to briefly discuss actually 743(b), basis adjustment, which more affects the buyer after the sale has taken place.

Let's just go through a quick example.

The purchasing partner, the new partner, paid $500 for the partnership interest.

But the purchasing partner's share of the partnership's inside basis, the $200, was on the GL for tax purposes.

It's only $200. That's the inside basis.

So what happens is, the partnership if it remains 750 for election, can make a 743(b) adjustment for $300.

This will then equalize the new partner's outside basis, $500, to now match their inside basis, which had been $200, the $300 743(b) adjustment to make this partner's share of the inside basis $500.

Alright, real quick, another one of these quick ones to make you aware of.

When the partners -- not the partnership but a partner -- who sells their partnership interest, and it contains 751 property, the partner must attach to their tax return a statement with these items on this slide.

Okay, next one. Here we go.

Hypothetical sale partnership asset.

The portion of the gain or loss that is subject to ordinary treatment under Section 751 is determined through a hypothetical sale of all partnership assets.

It just means we're going to do a computation and calculation and sell the assets just on a spreadsheet.

The partnership is treated as selling all its property in a fully taxable transaction, for cash, in an amount equal to the fair market value of the property.

The five-step hypothetical sale requirement is discussed in more detail on the next slide.

And real quick, I know we took a few tangents in the last couple slides, but now we're back on track, we're back to the unrealized receivable discussion.

Section 751 assets are items that will cause ordinary income treatment, and these include unrealized receivables and inventory.

And as we noted, depreciation recapture is a component of unrealized receivable.

So, first step, each partner must classify all their property as Section 751 property or an item of other property.

The next step is, every asset that the entity owns and determine the fair market value.

Third, the amount of the computed 751 gain, which you take every asset, assign their fair market value, their tax basis, sell them.

And this becomes your Section 751 gain, and you have to allocate it to each partner, based on the partnership agreement, which is usually the partner's interest in the partnership.

And real quick, to note, the amount of the 751 gains computed in Step 3 must be adjusted to account if a certain partner had built-in gain or lost property.

They may get allocated additional gain.

Or if any of the partners had a 743(b) adjustment allocable to them, that will reduce potential gain allocated to them.

Then, last, the residual gain is computed, which is the total gain on the sale of the partnership interest less the amount subject to 751 ordinary treatment, which we computed in Step 4.

The residual gain is subject to capital gain treatment.

Okay, now that we've introduced the hypothetical sale of partnership assets, we want to discuss some common areas of noncompliance.

This is something new.

Andrew and I agreed to show you what we've seen.

In our experience, it is common, the partnerships are not performing this hypothetical sale of its partnership assets when they are required to.

When the partnership is made aware that a third partner has changed ownership.

Without conducting the hypothetical sale, the partners will not have the information necessary to properly report the sale of their tax return.

Initially, for partnerships that do conduct this hypothetical sale, we've noticed that, commonly, the fair market value assigned to the partnership's assets at the time of sale is not reasonable.

So, now that we've given the background to the tax law, we want to discuss the Sale of Partnership Interest campaign.

This campaign was announced on March 13, 2018.

And as part of the campaign, Mike mentioned, it includes a variety of treatment streams which are soft letters, exams, we can talk to the customer in taxpayer outreach, tax software vendor outreach, and tax form changes which Andrew and I have been working on.

Next, we're going to talk about common areas of noncompliance at both partnership and partner level.

Okay, from what we've seen -- we just mentioned it so we wanted to cover it again -- the first area is, the partnership is not conducting the hypothetical sale.

And it's not providing a statement to the selling partners about their share of the gain.

That may be taxable at ordinary rates under the 751.

Or they also have to get the information announcing that it would be taxed at the higher capital gain rates of unrecaptured Section 1250 gain.

When these entities have been placed under exam, practitioners tell the partnerships they did not have to conduct a hypothetical sale as all of their assets have a fair market value equal to tax net book value.

However, in assets, tax net book value is not an estimate of fair market value and has nothing to do with changes in fair market value versus the depreciation methods.

For example, if a taxpayer takes bonus depreciation or expenses in asset, using Section 179, and the MACRS as an accelerated method, none of this has anything to do with the fair market value.

And just because they're using the accelerated method, it does not mean that an asset's true fair market value will be increased at the accelerated rate.

So, obviously, partnerships are using the wrong valuation methodology by looking at what an asset might sell at a liquidation or fire-sale value.

But the concept under aggregate theory is, the business is an ongoing business.

And the correct valuation methodology should be of going concern.

These assets are not being liquidated.

If a buyer is stepping into the shoes of the selling partner to continue this partnership as an ongoing business.

Okay, here, we're switching to partner-level areas.

Let's assume that the partnership did conduct a hypothetical sale analysis of assets, and that they also assigned a reasonable fair market value to all the partnership assets.

So the partnership should have provided to each selling partner a statement that shows their share of the Section 751 and unrecaptured Section 1250 gain.

Even if the partnership did everything right, it wasn't uncommon for us to see the partner failed to report their shares the 751 and/or unrecaptured Section 1250 gain correctly.

One reason can be that the statement is an attachment to the Schedule K-1.

It is not specifically shown on the Schedule K-1 as a separately stated item.

You need to know, maybe your partner misplaced the statement or they don't give it to their accountant.

And it ends up, they don't report the sale correctly.

Additionally, when there has been installment sale method, the selling partner does not always report the entire amount of the 751 gain in the year of sale as required.

Okay, final area of noncompliance is just the partner is underreporting the total gross proceeds from escrow amounts or different reporting items.

They aren't getting the correct sale amount they need to report.

Or they're overstating their basis.

Based on K-1 calculations, they are not quite getting that right.

We want to mention, as of 2019, the Schedule K-1 instructions have been modified, to include requirement of reporting Section 751 collectibles, unrecaptured Section 1250 gain, as a separately stated item with an alpha code.

So it's not, in that first list, once you'd be down there in that Box 20, where it's just open-ended, you can put in an alpha code and assign an amount.

But they are now at least required to get it on the Schedule K-1.

Okay, next, Andrew now is going to review the facts of Example 1 we started with and provide some additional details.

So, alright, Andy, you ready?

Andrew Dux: Yeah.

Thanks, Geoff, for an overview of the various tax laws relating to sale of partnership interest transactions.

Let's review Example 1 again that Geoff discussed earlier.

Partner "C" sold his 40% interest in ABC Partnership on September 30, 2018.

Partner "C" is an individual that files a Form 1040 tax return.

He received $19,000 in cash, had a $3,506 basis, and was relieved of his share of liabilities of $2,000 at the time the sales transaction occurred.

We can see, from the information above, that he would record a $17,494 gain on the sale of his partnership interest.

In order to determine the character of this gain, we need to look at the assets owned by the partnership.

This is the depreciation schedule of ABC Partnership, which Partner "C" sold his 40% interest in, as discussed on the previous slide.

As you can see, there were five assets owned by the partnership at the time the partner sold his interest -- a building, equipment, leasehold improvements, computers, and goodwill.

The building was placed in service in 1991, and the other assets were placed in service more recently.

The equipment and leasehold improvements both used bonus depreciation to partially depreciate these assets.

The tax net book value column, or adjusted tax basis, shows the tax net book value on the date when the partner sold his partnership interest, on September 30, 2018.

So the question is, what is the fair market value of these assets on the date of the sale?

This spreadsheet is exactly the same as the one on the previous page, with the exception of using the tax net book value of each asset as the asset's fair market value.

It is common to see partnerships use tax net book value as the fair market value of their assets.

By doing this, the partnership is basically saying, "The selling partner does not have to take any portion of their gain on the sale as subject to higher than the long-term capital gain tax rates." The building has an estimated fair market value of $2,895 if we just used tax net book value.

However, buildings generally do not decrease in value, except for in unusual situations like an economic depression.

The equipment has an estimated fair market value of just over $1,500.

This means that the fair market value decreased almost 50%, even though the partnership owned this asset just over one year.

The leasehold improvements have an estimated fair market value of approximately 30% of cost.

However, leasehold improvements generally last many years in a partnership's business operations.

The computers have an estimated fair market value of zero dollars.

Is zero dollars really an appropriate fair market value if these assets are still being used by the partnership in their business operations?

Finally, the tax goodwill asset has a estimated fair market value of just over $3,000, in comparison to its cost basis of $7,000.

So, with the limited amount of information available, let's ask ourselves, "Is a fair market value equal to each asset's tax net book value really correct?

We will come back to that question later, when we revisit this depreciation schedule again.

Okay, so, we've introduced the facts of Example 1.

And before we go further with this example, we wanted to take a step back and consider what is meant by the term "fair market value." Most of us on this call are accountants, not valuation experts.

However, it is important to consider what the definition of "fair market value" is for purposes of conducting a hypothetical sale of partnership assets.

This area of the tax law does not provide valuation techniques for assets.

Rather, the Internal Revenue Code just uses the term "fair market value." The most commonly referenced IRS site regarding fair market value is Revenue Ruling 59-60.

Revenue Ruling 59-60 characterizes the arm's-length definition of "fair market value" as the price at which the property would change hands between a willing buyer and willing seller.

Therefore, when a partner sells a partnership interest, we look at the fair market value using a going-concern valuation.

The seller is not selling these partnership assets at a bankruptcy option or a liquidation sale.

Instead, they are selling them to a willing buyer that wants to continue to use them in an ongoing business that continues to generate revenue.

Okay, Evette, now we are ready for CPE Question number 3.

Evette Davis: Thank you, Andrew. I think we can handle that.

Okay, audience, here is our third polling question.

"What is the proper valuation methodology when a partner sells its partnership interest?

Is it: "A," going concern; "B," liquidation or fire sale; "C," net book value; or, "D," GAAP book value?" Okay, folks, put your thinking caps on.

Take a moment, and click on the radio button that best answers the question.

And I will give you just a few more seconds to make your selection and think about what Andrew was talking about.

And I'm going to start my countdown.


Okay, folks, we are going to stop the polling now and then share the correct response on the next slide.

And the correct response is "A," going concern.

"A," going concern.

Now let's see what percentage of you answered that correctly.

Alright, looks like we are at 68%, Andrew.

So there is some confusion there.

Can you kind of take us back and explained to us why the response is "going concern"?

Andrew Dux: Sure, Evette.

So, yeah, the answer is, "A," "going concern." And basically what we mean by that is that generally when a purchaser buys a partnership interest, they are planning to continue to be a partner into the future.

And so they are buying this partnership interest to try to generate revenue and earn profit.

So the Service's position is that the partnerships assets at the time of the sale should be valuing using a going-concern valuation methodology.

Evette Davis: Okay, so they want to make sure that this business or partnership is valuable.

They want to make sure it is going to keep going, right?

Andrew Dux: Absolutely. Evette Davis: Awesome.

Alright, I'll turn it back over to you, Andrew.

Andrew Dux: Thanks, Evette.


Often, when there is a sale of a partnership interest, the buyer and seller have a signed sales agreement which discusses the fair market value they agreed to assign to the partnership assets.

One of the reasons this agreement exists, is to treat these assets consistently between the buyer and the seller.

A buyer assigns value for purposes of determining how their purchased assets will be depreciated.

Additionally, it is common for a seller to obtain an appraisal to further support his valuation assigned to the partnership's assets.

Although the seller may get an independent appraisal to support their position, the seller is motivated to have lower fair market value assigned to the partnerships assets.

And these appraisals are often not at arm's-length.

Treasury Regulation 1.1060-1(d), Example 2, gives the Service the authority to determine a correct fair market value when the taxpayer has failed to do so.

Just because the taxpayer has an appraisal, or there is an agreement between two unrelated third parties, does not mean the Service will respect it.

Agreements often seek to maximize tax savings between the buyer and seller.

However, these agreements do not override the tax law requiring items to be valued at their fair market value.

Okay, now we want to further discuss some common problems with the partnership's hypothetical sale computation on the next six slides.

Before we get back to discussing the facts from Example 1.

Some of these concepts might be a little repetitive, but the point of the next six slides is to provide an overview of the main areas of noncompliance identified by the Sale of Partnership Interest campaign.

A taxpayer's depreciation method really has no impact on an asset's decline in fair market value.

When considering fair market value, let's ask a couple questions.

Is the taxpayer using accelerated depreciation method, such as MACRS, Section 179, and bonus depreciation?

The fact that a taxpayer claimed bonus depreciation on a specific asset does not mean that this asset's fair market value decreased faster than if the taxpayer would not have taken accelerated depreciation deduction.

Has the taxpayer taken tax amortization deduction?

For Section 1250 assets, taxpayers sometimes takes bonus depreciation.

If an accelerated depreciation method was used, such as bonus depreciation or MACRS, then the gain on the sale will be recaptured as ordinary income to the extent by which the amount of accelerated depreciation taken exceeded depreciation that would have been allowed if straight-line depreciation was used.

One common practice we wanted to point out is cost segregation studies.

Taxpayers obtain cost segregation studies to separate out their depreciable assets into various asset categories, in an effort to obtain accelerated depreciation deductions.

Just because a partnership obtained a cost segregation study does not mean that the partnership's assets decreased in value faster than if a cost segregation study was not obtained.

When a partnership values its assets by conducting a hypothetical sale analysis at the time a partner sells its partnership interest, it is common for taxpayers to use a liquidation or fire-sale valuation methodology.

What would the assets be worth if the business ceased operating and the assets were sold at an auction?

By using this valuation methodology, it produces a lower fair market value than if a going-concern valuation was used.

The Service believes a partnership could use a going-concern valuation methodology.

The buyer and seller agree to an overall purchase price, and then this purchase price must be allocated across all assets.

The correct methodology is to consider each asset to continue to be used to operate a business to generate revenue.

Okay, another concept we want to discuss is older assets that have been fully depreciated.

A common observed filing position is that these assets are old and do not have any value.

However, the Service does not believe that position is correct.

The Service believes all assets that the taxpayer still owns and uses in its business operations have value.

Since they have been fully depreciated, whatever value is assigned to these assets would be recaptured under Section 751.

In order to continue to operate the taxpayer's business, they need these assets or they would have to purchase new assets to replace them to continue to operate at their current level.

If the taxpayer no longer owns these assets, then they should have removed them from their depreciation schedule.

Another common issue is leasehold improvements.

We have reviewed several common arguments regarding leasehold improvements.

Leasehold improvements have minimal value, as they would have to be removed and sold to someone that would not use them in the same way the taxpayer was using them.

Removing the leasehold improvements would damage them and diminish their value.

The partnership doesn't own the building, and if the business is abandoned, the contract states the leasehold improvements belong to the building owner.

The Service understands these arguments.

However, the correct valuation methodology is not being applied with these arguments.

There is a reason the taxpayer put these leasehold improvements in service.

The taxpayer believes they will add value and increase revenue for a long period of time.

At the time of the sale, the buyer is planning on using these assets in their current use.

They are not planning on selling them.

Therefore, the correct valuation methodology is a going-concern value.

When certain partnership interests are sold, some partnerships have existing intangible assets on the books.

These intangible assets were created in a prior transaction where the fair market value paid by the buyer of the entity at that time was greater than the tax net book value.

The partnership has amortized these intangible assets over the years by claiming ordinary deductions as amortization expense.

In the current year, when this latest sale of a partnership interest occurs, some entities are not allocating value to the prior intangible assets.

Instead, they create new intangible assets.

This results in the selling partner not having to recapture any of the prior amortization deduction.

The Service's position, in many cases, is, the existing taxed intangible assets on the books still have substantial value.

The existing intangible assets represent the ongoing knowledge and know-how existing in the entity, and the workforce in place.

The existing intangible assets are normally worth at least its original recorded value or more.

The valuation of the entity at the date of the sale should properly allocate value to these prior existing intangible assets.

Okay, so, if you remember the facts from Example 1, from a suit few slides ago, we have updated the spreadsheet to show estimated fair market value, using a going-concern valuation methodology.

The following fair market value estimations are purely, for this example, for discussion purposes, and we are not addressing the specific methodology used.

Generally, buildings do not go down in value unless there is a recession or an unusual fact pattern.

For this building, we are using an estimated fair market value of $14,000.

For equipment, these assets are only 14 months old at the time of the sale.

We have estimated a fair market value of $2,500 for these assets.

For leasehold improvements, these assets were about five years old at the time of the sale.

We have estimated a fair market value of $3,500.

For computers, these assets were about six years old at the time of the sale.

They are completely depreciated.

If the taxpayer were to sell these computers, it is likely they would not receive too much value.

However, they are still being used in the taxpayer's business operation, and therefore they still have some value.

We have estimated a fair market value of $500, or 20% of the cost.

For goodwill, this is a goodwill asset that was placed in service in 2010, which the taxpayer has been amortizing for tax purposes.

The estimated fair market value of this intangible asset is $14,500.

The partnership has increased in value since 2010.

And therefore, its existing goodwill asset went up in value, as well.

I want to express that I understand, the numbers on this table are not very large.

However, if we added several zeros to them at the end, you can see the materiality of this issue greatly increases.

When partnerships have taken ordinary depreciation and amortization deductions over the years, reasonable going-concern fair market value must be used in order to determine the proper character of the gain to be reported by the selling partners.

Okay, so, on this slide, we are continuing with Example 1 and conducting a hypothetical sale computation.

We are using the estimated fair market values that were discussed on the prior slide.

On this slide, it shows that 40% selling partner's share of Section 751 and unrecaptured Section 1250 gain.

On the top part of this computation, we just determined the partnership's total Section 751 and unrecaptured Section 1250 gain amount that would exist if 100% of the partnership interest was sold in the sales transaction.

Then, on the bottom part of the computation, we use the selling partner's ownership percentage to determine the amount applicable to each selling partner.

For buildings, we can see the total unrecaptured Section 1250 gain is $7,105.

For equipment, there is a total of $929 of Section 751 gain.

For leasehold improvements, there is $1,266 of Section 751 gain and $967 of unrecaptured Section 1250 gain.

Remember, if an accelerated depreciation method was used, such as bonus depreciation or MACRS, and the leasehold improvements are Section 1250 assets, then the gain on the sale will be recaptured as ordinary income, to the extent by which the amount of accelerated depreciation taken exceeded depreciation that would have been allowed if straight-line depreciation was used.

Any gain in excess of the amount traded as ordinary income because of Section 1250 recapture, but not exceeding the total depreciation claimed, is unrecaptured Section 1250 gain.

For computers, the entire $500 of gain is Section 751 gain.

For goodwill, there is $3,968 of Section 751 gain.

The remaining gain above the amount of previously taken tax amortization deductions is treated as capital gain.

So, as you can see, the 40% selling partner must report $2,665 of Section 751 ordinary gain and $3,229 of unrecaptured Section 1250 gain.

These amounts are simply computed by taking the total Section 751 and unrecaptured Section 1250 gain amount and multiplying them by the 40% partnership -- the partner's ownership percentage.

Now that we have discussed Example 1 in detail, let's discuss the partnership's reporting requirements.

The partnership is required to attach a statement to the selling partner's Schedule K-1, showing $2,665 in Section 751 gain and $3,229 in unrecaptured Section 1250 gain.

Additionally, the partnership is required to attach a Form 8308 to a Form 1065 tax return, explaining key information regarding the sales transaction, such as the date and the parties involved in the transaction.

Okay, Evette, do we have time for another polling question?

Evette Davis: We certainly do, Andrew. Thank you so much.

Okay, audience, here's our fourth and final polling question.

"What form must be filed by a partnership for each partner that sells a partnership interest when the partnership holds Section 751 assets?" Is it: "A," Form 1031; "B," Form 8949; "C," Form 8308; or, "D," Form 6198?" Alright, folks, like my teacher used to say, put your thinking caps on.

Take a look at these questions and the answers.

Just take a moment, click on the radio button that best answers this question.

And I'll give you just a few more seconds to make your selection.

And we'll begin the countdown in 5...4...3...2...1.

Okay, folks, we're going to close the polling now.

And let's share the correct response on the next slide.

And the correct response is "C," Form 8308.

Alright, drum roll, please.

Let's see what percentage answered correctly.

Whoo! 87%.

Andrew, I think they've awoken. So this is great.

You're just giving us a lot of great information.

We are on a roll.

Going to turn it back to you, Andrew.

Andrew Dux: Okay, thanks, Evette.

Yeah, 87% is excellent.

I'm glad everyone is learning and able to hear me clearly.

So, moving to the next slide.

The partner will use the information provided from the partnership to report its sale on its Form 1040 tax return.

The partner will have to report this on the right form.

For example, Form 4797 for Section 751 ordinary gain, or Form 8949 for capital gain.

The partner will consider the total proceeds received and subtract its basis to determine the total gain.

The taxpayer subtracts the gain amount taxed at rates higher than the long-term capital gain tax rate, from the total gain, to determine the remaining residual capital gain.

In this example, $11,600 is the residual amount that is taxed at long-term capital gain rates.

In summary, now you should be able to: identify the correct tax law related to sales of partnership interest; comprehend issues the Service has encountered during sales of partnership interest examinations; and finally, understand the Service's position on valuations placed on assets as part of the hypothetical sale computation.

Okay, Evette back to you. That's all I have.

Evette Davis: Thank you, Andrew.

Okay, everybody, take a deep breath.

Hello again. It's me -- Evette Davis.

And I'll be moderating the Q&A session.

But before we start the Q&A session, I want to thank everyone for attending today's presentation, "Sale of Partnership Interest." Earlier, I mentioned, we want to know what questions you have for our presenters.

And here's your opportunity.

If you haven't input your questions, don't worry, there's still time.

So go ahead and click on the drop-down arrow next to the Question field, and type in your question and then click and send.

Michael, Andrew, and Geoff are staying on with us to answer your questions.

Now, one thing before we start.

We may not have time to answer all the questions submitted.

And there are a lot.

However, let me assure you that we will answer as many as we have time for.

If you are participating to earn a certificate and related continuing education credits, you will qualify for one credit by participating for at least 50 minutes.

And that's from the official start time of the webinar, which means the first few minutes of chatting before the top of the hour does not count towards that 50 minutes.

Okay? Alright, folks.

So let's go ahead and get started and jump into these questions so we can get to as many as possible.

And I'm going to go ahead and start with you, Andrew.

This question I'm going to give to you, And it simply says this.

"You mentioned that the Service might not respect the valuation within a sales agreement or appraisal.

Why do you think the Service's position is better than our valuation experts when it comes to fair market value?" And then there's a second part, Andrew.

It says additionally, "What authority are you relying upon?" Andrew Dux: Okay, sure, Evette, I'll try to answer that.

It is a really, really good question.

So, basically, what we're saying is that when we have a sales transaction, generally, let's just say the buyer paid $20 million in cash.

Well, we're not arguing with the sales price.

Whatever two unrelated third parties paid each other, $20 million, we're not saying it should have been $30 million.

What we are saying is, this $20 million, or whatever the purchase price was, that this has to be spread across the partnership assets at the time of the sales transaction.

So this hypothetical sale computation that we talked about, the partnership has to look at all of their assets at the time of the sale, use going-concern valuation methodologies, and assign realistic fair market values so they can provide the correct information to the selling partners to report the gain or loss on the sale transaction.

And I think the second part of your question asked about the authority.

And The Service relies upon Treasury Regulation 1.1060-1.

There's an example in the Treasury regulations that basically says, if the taxpayers, the partnership does not assign reasonable fair market values, that the Service does have the authority to come in and change these valuations to make sure they properly reflect the fair market value of the partnerships assets.

Evette Davis: Awesome, awesome. Okay.

Thank you for that detailed response, Andrew.

We appreciate that.

Okay, Geoff, clear your throat. I'm going to come over to you and ask you a couple of questions, alright?

Geoff Gaukroger: Okay. Sounds good.

Evette David: [ Laughs ] Alright, this person is asking, "If a client is a limited partner in a limited partnership, and sells its interest in that partnership, it is unlikely that the limited partner would have this information," as far as the value is concerned, I'm guessing they're talking about.

"So, partnerships generally do not include this detail on Schedule K-1.

What is the client's obligation?

And does it have to ask the partnership to provide that detail?" Geoff Gaukroger: Alright.

For this job, he had been reading through hundreds and hundreds of -- You guys are asking great questions.

If you haven't had the fun of being in an IRS exam, Andrew and I really do enjoy working with you guys.

So, in this question, what they're saying is the client, you have a limited partnership.

And maybe even, a distance away, you have a tier, another limited partner, and you have a partner getting the K-1.

Could be 20 states away.

What is your responsibility if you're preparing the 1040?

And do you have to ask the partnership?

Well, again, this is sort of unofficial answers.

We'll just tell you that our job in LB&I, a lot of businesses are international.

We deal with the business entity.

That business entity should have been giving that correctly.

If you're a partner in a partnership, hopefully, you're interacting with an ethical, good, professional entity that is doing what they should be doing.

But I would think, especially now, we've moved from TEFRA to the BBA, where exam adjustments are going to be assessed at the entity level. So it really is, if you live in Seattle and the partnership is in Florida, you have no connection.

You just report based on the K-1.

And the entity is really the one that's got it.

So if you're preparing partnership returns, that is your responsibility to do this for your client.

Evette Davis: Okay.

That was a pretty good shot, there, Geoff.

Okay. Geoff Gaukroger: [ Chuckles ] Okay. Yeah.

Evette Davis: They have some great questions here.

Okay, Andrew, let me come back to you for a question here.

It says, "For the calculation of Section 751 gain, how is the fair market value of the asset determined?

Hypothetical sale by the partnership of all its assets at fair market value to determine the Section 751 gain, [Audio drop] ...assets using Section Code 1060." Hmm.

Andrew Dux: Okay, so, yeah, that's a really good question and something to consider. So, I would say, generally, the question talks about a hypothetical sale.

So when there is a sale transaction, the partner notifies the partnership, and the partnership has to do this hypothetical sales transaction.

And whether the selling partner was a 99% owner or a 1% owner, that is potentially something that you have to consider.

But, in reality, the buyer that's coming into this partnership, they are planning to continue, generally speaking, and to continue to operate.

They are not coming into this business and saying, "Hey, I want to purchase 10% of a partnership.

And the next day, I want to sell everything.

All these assets are worthless." So what I would say is, the partnership's responsibility is to use going-concern valuation methodologies to apply fair market value across the board to all these assets at the time of the sale, using all the information available at the time of the sale transaction.

Evette Davis: Okay. Okay, okay. That's good, that's good.

Okay, Geoff, kind of in keeping with the hypothetical sale, what happens to the difference between fair market value of assets in a hypothetical sale and then actual sale price of a partnership interest?

Geoff Gaukroger: Okay, so, good question.

What we're seeing here is, say, we have a partnership that started out, original basis for everyone is $5 million.

And we have five partners.

So they each have a fair market value of $1 million in the partnership.

And the partnership has gone up in value to $10 million.

Well, if one of the partners decides to sell, they're going to go sell their partnership interest for $2 million.

And so this new partner, we do the hypothetical thing, take all the fixed assets...

I just got to think of a couple.

Inside basis, first.

Inside basis is just the general ledger for tax purposes for the entity.

So, that's what exists at the time we do this hypothetical sale at the entity level for everyone to determine the gain.

And this is where that 743(b) adjustment ends.

It's only going to be for one partner.

So what happens is, the partner who paid $2 million is now going to get a step up in basis.

And in allocation sense, under Section 755, to five years MACRS 7, 15-year asset.

Any extra money, because again this partnership went from $5 million to $10 million, the extra money paid by the buyer goes to a new asset, which is goodwill.

It's put on the safe side, just for tax purposes.

It's called purchase goodwill.

And it can be amortized over 15 years.

that was a hard question and a quick answer, but, hopefully, some people followed that.

Evette Davis: [ Chuckles ] You did a great job. [ Chuckles ] That's alright.

These guys are sharp, and they know what they're talking about.

So I am very confident in the answers and responses that they're giving you, along with some resources that you can all go back in and review.

Okay, so, Andrew, let me come back to you with a question here.

And this says simply, "How does a minority partner determine if there are any Section 751 assets at the time he or she disposes of their interest in a partnership?

Andrew Dux: Okay, so, that's a really good question.

And so if a selling partner -- if a partner sells their interest, whether they are 1% partner or 50% partner, they just need to be in communication with the partnership and tell them.

And then it's the partnership's responsibility.

They have all the partnership books and records.

And they have to compute the hypothetical sale.

And then they would provide that information to the selling partner, who would in turn use that information to report the sale correctly on their tax return.

Evette Davis: Wow. Oh, my goodness.

Okay. That was great.

I cannot believe this, audience, but that's all the time we have for questions.

What great question they were. What great responses.

I want to thank Michael, Andrew, and Geoff for sharing their knowledge and expertise and for answering your questions.

But before we close the Q&A session, Andrew, what points or key points do you want the attendees to remember from today's webinar?

Andrew Dux: Okay, sure, Evette.

We have six key points that we want the audience to remember.

The most common Section 751 assets are depreciable and amortizable assets.

Just because the taxpayer has an appraisal or there's an agreement between two unrelated third parties does not mean the Service will respect the fair market value allocations to the assets.

The agreement must reflect reasonable valuations to partnership assets.

The partnership must conduct a hypothetical sale analysis and assign a reasonable fair market value to each asset using a going-concern valuation methodology.

It is the Service's position that the correct fair market value to be assigned to the partnership's assets at the time of the sale is a going-concern value where the buyer is continuing to use the partnership's assets as the selling partner was at the moment of the sale.

A liquidation or fire-sale value, as if all assets were being disposed of, is not a correct valuation methodology.

A partnership must file a separate Form 8308 for each partner that has a sale or exchange when Section 751 assets were owned by the partnership.

Penalties may be asserted against the partnership for failure to file a Form 8308.

Starting in 2019, there is a new requirement on Schedule K-1.

If a partner's capital account is decreased due to a partner selling a partnership interest, a box must be checked.

We also wanted to mention that this issue appears to be more significant due to the Tax Cuts and Jobs Act.

TCJA allows taxpayers to expense 100% of the cost of certain qualifying property acquired after September 27, 2017.

This will accelerate the timing of depreciation deductions and increase the potential of Section 751 adjustments if a partnership uses a liquidation valuation methodology for computing Section 751.

Okay, Evette, back to you.

Evette Davis: Thank you so much, Andrew.

I appreciate that.

Okay, audience, we are planning additional webinars throughout the year.

To register for an upcoming webinar, please visit, keyword search "webinars," and select the Webinars for Tax Practitioners or Webinars for Small Businesses.

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Again, a big thank-you to our speakers for a great webinar, for sharing their expertise, and for staying on to answer your questions.

I also want to thank you, our attendee, for attending today's webinar, "Sale of Partnership Interest." And, audience, if you attended today's webinar for at least 50 minutes from the official start time of the webinar, you will qualify for one possible CPE credit.

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