 Hello and welcome to this session in which we will discuss distribution from a partnership. The first thing we need to understand that not all payments made from the partnership to a partner are treated as distribution because money between the partnership and various partners could take place in different forms such as interest payments. The partners sometime what they do they lend money to the partnership as a result the partnership might pay them interest in return of their lending well that's that's an exchange that's a distribution but it takes the form of an interest. Another form could be the partners they have their own property plant and building in a separate C corporation or an S corporation or a sole proprietorship and they might rent that property to the business and the partnership the business will pay rent to the partners. Also we talked about guaranteed payments and we specifically stated that guaranteed payment are not distribution and we had one whole session about guaranteed payment and there could be exchanges buying and selling between the partners and the partners and the partnership and sometimes it could amount to related party transaction nevertheless it is a form of distribution or exchange between the two parties. So first we need to know that distribution is different than that than any of those. So let's go ahead and talk specifically about the various types of distribution that we could have. Before we proceed any further I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true false questions as well as exercises. Go ahead start your free trial today. There are two types of distribution that we need to be aware of when it comes to partnership. We have a liquidating distribution and non liquidating or called current distribution. Now what is the difference between the two? Well in both situations you can distribute cash, you can distribute property. So distribution basically when the partnership distribute cash or property to the partner and it could be a liquidating distribution or a non liquidating. What is liquidating distribution? When liquidating distribution is simply put when the partnership liquidates and distribute all the properties to the partners. Simply put we're going out of business. We are closing. This is what a liquidating distribution means basically you know closing the business. This is one form of liquidating distribution. Another form of liquidating distribution is when a partner redeem their interests such as in the case of retirement. That's also called a liquidating distribution. Basically you are ceasing to be a partner. This is basically what a liquidating or the business cease to exist as a partnership. Now we have a non liquidating distribution. Well simply put well it's not a liquidating distribution. It's called also current. We are still in business. We are open and as a partner we are still a partner. This usually occur when the partner remains a partner in the partnership after the distribution and this is the common one. You get a distribution from the partnership. You stay as a partner. The partnership continue as a viable business life goes on. So in this session and generally speaking on a CPA exam or in your accounting course we usually cover current distribution or non liquidating distribution. Also within distribution we have to differentiate between a proportionate and disproportionate distribution. So we need to know what is proportionate and what is disproportionate. Just as they as the term suggests proportionate it means you receive your share of that distribution. Proportionate distribution occurs when a partner receives their share whatever their share is of certain ordinary income producing asset. So if you own 30 percent you're going to get 30 percent of that distribution means you're getting whatever you proportion proportionally sharing. Under those circumstances not under those circumstances under this type of distribution under proportionate distribution which we're going to be discussing more proportionate so it's going to be current and proportionate distribution that we're going to be working with. Generally speaking there's neither the partner nor the partnership recognizes gain or a loss. Generally speaking on a proportionate current distribution. Typically speaking generally speaking no gain no loss. You know when I say generally and typically means there's always an exception right but generally there's no gain and no loss. Usually the partner takes the carry over basis and the asset distributed so the basis from the partnership is basically transferred to the partner. The partner basis and the partnership interest is reduced so once you have a distribution remember distribution reduces your basis it reduces your basis. So if they gave you a property with a basis of a ten thousand dollar then whatever your basis is if your basis are one hundred thousand now you reduce your basis by ten thousand down to ninety so distribution reduces your basis but it cannot reduce your basis below zero. What happen if you receive more than your basis? We'll talk about this okay so you would reduce your basis. This proportionate distribution which is which is not proportionate happens when a partner share of a certain ordinary income producing asset either increases or decreases their asset means you're getting more or less than what you are worth in terms of equity. So what does that mean specifically it's mean when you distribute of asset or income that's not proportional to the partner's original equity stake to their equity stake and when would that happen? Well under unique circumstances I mean I'm gonna say for example you want to get rid of a partner just give them you know say you know what you own 30 percent we're gonna give you 35 percent share but we want you to get a leave basically something like this something like this or a special arrangement special arrangement special arrangement but again we don't worry about this proportionate distribution we're gonna be working with with current distribution that is proportionate. Now what can we distribute? Well we can distribute cash or sometime we could have a debt relief basically the debt relief is the same thing as if you're giving someone cash. If we have a cash distribution a partner might have to recognize again if the cash distribution is greater surpasses the partner's adjusted outside basis in the partnership. So if your outside basis is a hundred ten thousand and we gave you twelve thousand dollar in cash we gave you two thousand more than what your basis are your outside basis well guess what you have ten thousand dollar basis we gave you more we return all your money in addition to that we gave you an additional two thousand dollar where the two thousand dollar guess what it's again remember basis is return of capital return of capital is not taxable it's not taxable the ten thousand basically we're giving you back what you gave us the basis you built those basis over the years but we're giving you way more than what your basis therefore that addition is what is taxable. Also the reduction the reduction the decrease and the partner's shares of the partnership debt is treated as cash distribution so every time the debt goes down to the from the partnership your share of the debt goes down it's as they gave you cash loss is recognized no loss is recognized by a partner in a current distribution there's no such thing as loss you don't recognize loss. Now how does how does this all impact the basis well just review this type of distribution first lower the basis of the partners in the partnership as I told you if you receive cash you lower your basis if it's an access if the reduction exceeds the partner's basis it results in a taxable gain basically this is a summary of what we just said we could also in addition to cash we can distribute property again typically no gain is recognized on the property however if the inside basis of the distributed property is greater than the partner's outside basis and the partnership interest then the distributed asset assumes a substitute basis what does that all mean we're going to see in a moment an example but simply put if your basis if you're giving something worth 50 000 and the outside basis of the partner is 40 you're given the more than their basis then we're gonna use the the partner will assume a substitute basis don't worry we'll see what that in a moment in an example what happened if we distributed multiple assets we could distribute cash inventory a property plant and equipment various property here's what happened there's an order that we have to follow when that happens assets are considered distributed and basis is assigned in the following order first we say it's the cash amount then if we gave receivable and inventory we reduce the basis by the receivable and inventory which is those are called hot asset then all other assets comes third okay and the basis is allocated to asset within within a category based on their adjusted basis the partnership don't worry we'll work an example illustrating all these concepts let's look at an example that illustrate every concept that we just talked about so we're gonna have six different scenarios so focus with me on each scenario separately starting with a i'll start with a simple example then we we add to it in scenario a we have an asset distributed is cash so we're distributing only cash that's all we're distributing to a partner with the basis of 300 000 what's gonna happen well the basis is 300 000 the cash distributed it's gonna reduce the basis by 150 we did not relieve any debt basis after cash and that relief is 150 there's no gain recognized we did not give them any account receivable so basis after account receivable is 150 we did not give them any land the basis of their land is 150 therefore basis after all distribution in the partnership is 150 now if this partner sells their interest in this partnership for 170 they have a gain of 20 000 on their partnership interest if they sold their interest but simply put all what we did here is we distributed cash and we saw the results what happened to the basis let's look at example b an example b we distributed cash of 150 we distributed a piece of land for with the with the basis of 60 fair market value of 100 000 okay so we gave them cash and land well the basis the basis in the partnership is 300 000 what do we do first in the order we first we look at the hot asset cash 150 300 000 minus 150 basis after cash is 150 well we don't have any account receivable basis after account receivable which is the hot asset still 150 now we have land we have fair market value and basis we just ignore the fair market value 150 minus the basis of the land distributed your basis after all distribution in the partnership is 90 000 90 000 and your basis is in the land 60 000 and your basis in the land is 60 000 let's look at scenario c in scenario c we distributed cash and we could we distributed an account receivable with the basis of zero and fair market value of 160 the partner has interest of 300 000 again 300 000 minus the cash will give us a basis of 250 after the cash distributed then we have the basis of the basis of the receivable and fair market value we ignore the fair market value the basis is zero two the basis is zero 250 minus zero equal to 250 minus the zero land equal to 250 therefore the basis now is 250 now once you collect the the account receivable it's considered income to you but again because the basis of the account receivable is zero let's look at scenario d scenario d we gave a cash of 400 000 the basis in the partnership is 300 000 what is unusual about scenario d is we gave them more than the basis so the cash received is an access so the cash that we gave them is greater than the outside basis so 300 000 minus 400 000 will give us a basis in quote a negative basis of 100 000 there's no such thing as negative basis of 100 000 what's gonna happen is we're gonna take this 100 000 and recognize it as a gain recognize it as a gain we're gonna recognize 100 000 as a gain simply put even if we had negative once we recognize the gain negative 100 000 once since we paid the taxes on the gain of 100 000 that 100 000 bring our basis up to zero but simply put we recognize it as a gain because we cannot have negative basis well if that's the case we don't have a counter receivable we don't have land so your basis is zero so this is where we have the cash is an access the cash is an access of the basis let's look at scenario e scenario e we did not give cash which is basically relief of liabilities of 400 000 what did i say about relief of liability it's as if they gave you cash if someone tell you you're not responsible for 400 000 well thank you very much you just gave me 400 000 because i was supposed to pay this that and you took it over as if you went to the bank paid the bank on my behalf or as if you gave me the money i went to the bank and i paid it you gave me 400 000 thank you very much i will take it same thing as cash same concept the basis is 300 000 the partner has a that relief of 400 000 therefore the basis is negative 100 000 in quote we cannot have a negative basis what are we going to do we're going to recognize again of 100 000 and the basis will will be back to zero and that's the end of the story let's look at scenario f we gave cash of 200 000 we gave land adjusted basis of 300 fair market value of a half a million i could take out the fair market value the basis in the partnership is 300 000 first we're going to take the cash reduce the basis and the basis after the cash is 100 000 okay that's fine do we have any gain we don't have any gain yet because you know we did not receive cash and access but what we what we are giving is a land with the basis of 300 000 if we deduct 300 000 out of 200 000 we're going to be a negative 200 000 well we cannot be negative basis of 200 000 so what's going to happen is we're going to say of that 300 000 of that 300 000 we're going to use 100 000 as the adjusted basis to bring our basis down to zero and we're going to take this this land and our adjusted basis in the land is our substitute basis up what's left in our basis 100 000 therefore the land will have a substitute basis the land will have a substitute basis of 100 000 so what did we technically do when we substitute the land so the land has a basis of 300 000 so if somebody gave you land they say okay i'm going to give you two options do you want the land basis to be 300 000 or do you want the land basis to be 100 000 and your choice should be basis doesn't matter it's not going to give me more or less money but you say i want my basis to be 300 000 why because if you sold this land for 400 000 in the future you would say i sold the proceeds are 400 the basis is 300 in the future you will pay let's choose something other than 400 let's assume you sold it for 450 you have a gain of 150 000 now what's going to happen is if you sold it for 450 and you have an adjusted basis of 100 000 which is your substitute basis your gain if my math is right is 350 and you don't want 350 you want the gain of 150 but you can do that because you are taking the adjusted basis all what you did is you deferred that gain for later until you sell that land this is what's that was what technically happened and your basis in the partnership is zero so every time if you want to sell your interest even if you sell it for a dollar that dollar will be again the the basis in the partnership so what i did i showed you a few examples various example that illustrate the various concepts when we have what type of a distribution current distribution current distribution and what type of distribution current and proportionate distribution so just keep in mind this is what we are working with it's very important to understand how distribution is treated for a partnership what should you do now go to far hat lectures look at additional lectures multiple choice true false resources notes that's going to help you do what understand this concept better whether you are a CPA candidate or an accounting student invest in yourself don't shortchange yourself good luck study hard and stay safe