 Hello and welcome to this session in which we will discuss the liquidating distribution of a partnership. In a prior session we looked at non-liquidating distribution and the difference between the two is in the liquidating distribution the partnership simply put its closing, we're closing the business, we're closing all the accounts and that matters that that's relevant to understand what's liquidating because we have to deal with basis and when we're liquidating we have to get rid of the basis we are gone the basis should go down to zero so the nature of the liquidating distribution can take place as a singular event simply put you can you know close the business in one event or may occur in a series of event they could close the business in various steps the end of the day the partners is exiting the partnership simply put the partner is gone the business is closed and the partners full exit from the partnership is the end product so when the partnership liquidate proportionally and remember we have proportional and disproportional proportional means you're going to get exactly the value of your percentage ownership under those circumstances no gain and no loss is recognized by the partnership and we will work a liquidating proportional distribution it will be helpful if you understand or if you reviewed before we go through this session the rules for non liquidating distribution that's proportional because it's similar in a way but not the same so let's go ahead and get started 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 as I mentioned ordering rules and liquidation are similar to the non liquidating or the current or the current distribution the rules for assigning liquidating distribution are similar similar means not the same similar but it's very important or very helpful if you remember your current non liquidating distribution assuming we have a gain scenario and we will discuss what a gain scenario in a moment gain means I'm specifically saying no loss because under a loss we're going to have different scenarios the ordering rules are the follow first we distribute the cash then we distribute the hot asset unrealizable receivable and inventory then the third step it's going to be a little bit different any remaining outside basis gets allocated to the other assets received because what we have to do is we have to zero the basis why because we are dealing with the liquidation so we're going to see what that means but this is the step where the word they differentiate this allocation of partnership interest does not apply when the partner is required to recognize a loss and we're going to look at a loss situation because the rules might be a little bit different let's take a look at a normal distribution with the gain first we distribute the cash cash is the first asset to be distributed during liquidation if the cash distributed is greater than the basis then we have a gain and we already know this from the current distribution or non liquidating distribution now the distribution of cash which include deemed cash like what relief from the partner share of partnership that if they relieve you from that it's the same thing as they gave you cash that reduces the liquidated partners outside basis dollar for dollar remember basis cannot be cannot be below zero we could go down to zero then the next thing if you have anything left any basis left and we have inventory we're going to distribute the unrealized receivable and inventory so following the cash unrealized receivable and inventory are next to be distributed now these assets received a basis equivalent to the lesser of these two values so what what amount do we assign to that ar unrealized ar or receivable the basis is the the the the lower of the partners inside basis and those assets the partnership not the partner the partnership inside basis or the remaining outside basis of the partner because once you get to the eliminate the outside basis of the partner you can't go below zero so the lower of these two will be used so the partner's outside basis is reduced by the amount of basis allocated to these ordinary income producing asset remember we our goal is to bring your basis down to zero outside basis down to zero the third step remember the third step is they is where they differentiate they differentiate between liquidating and non liquidating the difference between liquidating and non liquidating becomes apparent at this step if the liquidating partner has any remaining outside basis whatever that outside basis is it's allocated to all asset received in this step during the liquidating distribution why again we want the outside basis at this step to go down to zero now the best way to illustrate this is to look at an example so let's assume john has uh has a basis of 80 000 john received 20 000 in cash so they started with 80 000 in basis first step we're going to allocate the cash and cash the basis and the fair market value is the same basis after the cash is 60 000 then a proportionate share of inventory remember this is a proportionate distribution with the basis of 25 fair value of 35 we eliminate the fair value we're going to take out 25 000 for the inventory therefore what's left is 35 000 then they get a building with the basis of 10 000 fair value of 15 well hold on a second we're giving them they still have 35 000 we're giving them an asset with a fair value of 15 and a basis of partnership of 10 first of all we're going to use the fair value but even if we give them a ten thousand dollar even if we give them the ten thousand dollar basis follow the rules if we follow the rules as we learn what's going to happen if we allocate 10 000 what's going to be have what's going to happen is we're going to have 25 000 remaining we can't have 25 000 remaining this is not a current or non liquidating this is a liquidating what does that mean it means the building will take a basis of what of 35 000 to bring down the basis to zero so the distribution liquidate both the partnership and john and pire interest we have no hot asset other than the inventory and it's a proportionate distribution we recognize no gain and no loss so first 80 minus 60 will give us 80 minus 20 will give us a remaining balance of 60 then the 60 is reduced by 25 to 35 and the step three the building absorbs john remaining partnership basis of 35 000 of 35 000 why because we need to remove it we need to remove the basis the basis will need to go down to zero that's the purpose of it that's the logic because if we are liquidating what would john do with the remaining basis if the business don't exist we could also have what's called step down and stop step down and stop up basis when a multiple asset are distributed within the same class special rules may apply under those circumstances let's see how what are they we could have a step up step up may be necessary or a step down might be necessary what does that mean the partners remaining basis whatever remaining basis we have for the partnership interest is less than the partnership basis for the distributed asset in that class so the partners remaining basis whatever that remaining basis are let's assume it is remaining basis of 35 000 is less than the partner's basis for the distributed asset so whatever we have left is maybe uh you know 20 000 uh i'm sorry it's less it let's assume 40 000 okay the partner's remaining basis for each distributed asset is proportionally reduced what's going to happen is remember the asset inside the partnership the partnership basis for the distributed asset is less than the partner's basis what's going to happen is let's assume this is john this is john basis okay and this is the partnership basis in the distributed asset well john basis are lower what we have to do is we have to reduce it proportionally the reduction is done to minimize the difference between each asset basis and its fair market value and we're going to look at an example to illustrate this concept this is a step down we could also have a step up we're going to look at an example with a step up but the same concept will apply here's the partners remaining basis for the partnership is greater so if we have 30 if john has let's keep it at 35 000 it's greater than the partnership basis for the distributed asset in the other asset class other asset means not cash and not what and not hot asset not inventory or receivable a different rule would apply the partners basis for the asset and that class is determined in a way that ensure the basis amount are proportionate to that the fair market value so we're going to use the proportionate fair market value of the distributed asset in that class well hold on a second could you give me an example yes let's take a look at an example let's go back to the john's example same example as john except that john received two buildings at the end remember john had let's go back to that example so we're going to look at the same example where we have 80 minus 20 gave us 60 000 then we reduced it by the inventory where remain was 35 except now with the 35 000 we are giving john two building one building with the basis of 4 000 the other building is basis of three now the fair market value of these buildings are equal so the fair value are the same just for the sake of illustration it doesn't matter they can be 60 40 40 30 you know 30 70 it doesn't matter in this scenario john recognizes no gain and no loss here's what's going to happen we're going to take the 80 minus the 20 we're going to go down to 60 then we're going to take the 60 minus the 25 brings us down to 35 000 what's going to happen is this the 35 000 that's left since we have two assets we have 35 000 left and we have two assets how are we going to allocate the two assets well the basis is four and three we're going to have a step up and use the fair market value and assign for each asset 17 500 50 50 percent because the building has equal fair market value so what we did here is we did a step up and the opposite would have been true if we had to do a step down but this is basically how it works let's assume where we have a loss recognizing loss and a liquidating distribution so when do we have a loss in a liquidating distribution we can only recognize a loss if two conditions are met here we are working with the losses different than a game scenario the partner receives only cash unrealized receivable or inventory so we're only receiving cash or hot asset now it's critical to to know the word only okay a distribution of any other type of asset would remove the loss okay so we are only receiving cash and hot asset and no other third type of assets and the partner's outside basis is greater than the inside basis for the hot asset so basically we're getting less than what our basis are okay so the basis of the hot asset cannot be increased you cannot increase the value of the inventory you cannot increase the value of the receivable as a result the assets in step two take the carry over basis and the partners can claim a loss for any remaining basis and the partnership interest let's look at an example Sarah's outside basis is 50 000 she received a liquidating distribution of 10 000 in cash and a proportionate share of inventory have a partnership basis of 5000 fair market value of 15 remove the fair market value now we are not allowed to have a step-up basis of the inventory okay and you can obviously you cannot have a step-up basis for the cash if you say 10 000 cash you cannot say well the fair value of the cash is worth more you can do that right so cash is cash so Sarah is not allowed to step up the basis of the inventory neither so 5000 is allocated so what's going to happen is this Sarah started with 50 cash 5 inventory cash 10 inventory 5 what's left is 35 000 okay because she received a distribution only with cash and inventory now the 35 000 is what to her the 35 000 is a loss recognize a capital loss of 35 000 on the liquidation okay now let's assume change the example a little bit and assume Sarah receives a piece of furniture from that partnership with the adjusted basis of a thousand that was used that was used in the partnership ignoring any depreciation recapture to say she received a piece of furniture well guess what remember that 35 000 that's a loss then the furniture will absorb the basis then would say the furniture will have a basis of 35 000 and the capital loss is basically evaporated gone evaporated gone what should you do now you should go to far hat lectures and look at additional resources lectures multiple choice through false that's going to help you understand this concept it's very important that you reinforce what you know through practice why because you want to test your knowledge and far hat lectures will give you that option whether you are a CPA exam candidate an accounting student invest in yourself or an enrolled agent invest in yourself good luck study hard and stay safe