ExpertMedium1 markMultiple Choice
CPA · Question 40 · Area II: Entity Tax Compliance
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?
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:
A.
$20,000 Capital Gain
B.
$20,000 Ordinary Income
C.
$10,000 Ordinary Income, $10,000 Capital Gain
D.
$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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