ExpertHard1 markMultiple Choice
CPA · Question 47 · Area II: Entity Tax Compliance
A partnership makes a liquidating distribution to Partner J. Partner J's outside basis is $50,000. J receives $10,000 cash and inventory with a basis of $20,000 (FMV $25,000). No other assets are received. What is the result?
A partnership makes a liquidating distribution to Partner J. Partner J's outside basis is $50,000. J receives $10,000 cash and inventory with a basis of $20,000 (FMV $25,000). No other assets are received. What is the result?
Answer options:
A.
J takes a basis of $40,000 in the inventory.
B.
J recognizes a $20,000 capital loss.
C.
J recognizes $0 gain/loss; remaining basis disappears.
D.
J recognizes a $20,000 ordinary loss.
How to approach this question
Liquidation Rule: 1. Reduce basis by cash. 2. Reduce basis by hot assets (Inventory/Receivables) at INSIDE basis (cannot step up). 3. If basis remains and NO other assets received -> Capital Loss.
Full Answer
B.J recognizes a $20,000 capital loss.✓ Correct
J recognizes a $20,000 capital loss.
IRC §731(a)(2). Loss is recognized on a liquidating distribution if only money, unrealized receivables, and inventory are received, and the partner's basis exceeds the sum of money plus the basis of the property received.
Common mistakes
Stepping up the inventory basis to absorb the loss (inventory basis is capped at inside basis).
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