ExpertHard1 markMultiple Choice
CPA · Question 37 · Area II: Entity Tax Compliance
A partner receives a liquidating distribution consisting of $10,000 cash and inventory (Basis $5,000, FMV $8,000). The partner's outside basis was $20,000. What is the tax consequence?
A partner receives a liquidating distribution consisting of $10,000 cash and inventory (Basis $5,000, FMV $8,000). The partner's outside basis was $20,000. What is the tax consequence?
Answer options:
A.
No gain or loss; Inventory basis is $10,000.
B.
$5,000 Capital Loss; Inventory basis is $5,000.
C.
$5,000 Capital Gain.
D.
No gain or loss; Inventory basis is $15,000.
How to approach this question
Liquidating Distribution Rules: 1. Reduce basis by cash ($20k - $10k = $10k). 2. Assign basis to hot assets (Inventory) equal to partnership basis ($5k). Cannot step up inventory. 3. Remaining basis ($5k) is a Capital Loss if no other assets received.
Full Answer
B.$5,000 Capital Loss; Inventory basis is $5,000.✓ Correct
B
IRC §731(a)(2). Loss is recognized if only money and unrealized receivables/inventory are received and their basis is less than the partner's outside basis. Outside ($20k) - Cash ($10k) - Inventory Basis ($5k) = $5,000 Loss.
Common mistakes
Stepping up the basis of inventory to absorb the excess outside basis.
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