Partner A sells their partnership interest for $50,000. Their outside basis is $30,000. The partnership holds inventory with a basis of $10,000 and FMV of $20,000. How is the gain characterized?

Answer options:

$20,000 Capital Gain

$20,000 Ordinary Income

$10,000 Ordinary Income, $10,000 Capital Gain

$5,000 Ordinary Income, $15,000 Capital Gain

How to approach this question

Total Gain = $50k - $30k = $20k. Hot Assets (Inventory): Partner's share of ordinary income if sold = $10k (assuming 100% or proportionate, scenario implies A bears this). Ordinary Income = $10k. Residual Capital Gain = $20k - $10k = $10k.

Full Answer

C.$10,000 Ordinary Income, $10,000 Capital Gain✓ Correct

IRC §751(a). The partner must recognize ordinary income equal to their share of the partnership's gain on hot assets ($20k FMV - $10k Basis = $10k). The total gain is $20k. So $10k is ordinary, and the remaining $10k is capital gain.

Common mistakes

Treating the entire gain as capital.

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