Publication 541 (Rev. January 2016) P541
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- Contents
- Reminder
- Introduction
- Forming a Partnership
- Terminating a Partnership
- Exclusion From Partnership Rules
- Partnership Return (Form 1065)
- Partnership Distributions
- Transactions Between Partnership and Partners
- Basis of Partner's Interest
- Disposition of Partner's Interest
- Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
- How To Get Tax Help
- Index
Contents
Reminder .................... 1
Introduction .................. 1
Forming a Partnership ............ 2
Terminating a Partnership ......... 3
Exclusion From Partnership Rules .... 4
Partnership Return (Form 1065) ...... 4
Partnership Distributions .......... 4
Transactions Between Partnership
and Partners ............... 7
Basis of Partner's Interest ......... 9
Disposition of Partner's Interest ..... 11
Tax Equity and Fiscal
Responsibility Act of 1982
(TEFRA) ................ 13
Index ..................... 15
Reminder
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Introduction
This publication provides supplemental federal
income tax information for partnerships and
partners. It supplements the information provi
ded in the Instructions for Form 1065, U. S. Re
turn of Partnership Income, and the Partner's In
structions for Schedule K1 (Form 1065).
Generally, a partnership doesn't pay tax on its
income but “passes through” any profits or los
ses to its partners. Partners must include part
nership items on their tax returns.
For a discussion of business expenses a
partnership can deduct, see Publication 535,
Business Expenses. Members of oil and gas
partnerships should read about the deduction
for depletion in chapter 9 of that publication.
Certain partnerships must have a tax mat
ters partner (TMP) who is also a general part
ner. For information on the rules for designating
a TMP, see Designation of Tax Matters Partner
(TMP) in the Form 1065 instructions and sec
tion 301.6231(a)(7)1 of the regulations.
Department
of the
Treasury
Internal
Revenue
Service
Publication 541
(Rev. January 2016)
Cat. No. 15071D
Partnerships
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Many rules in this publication do not
apply to partnerships that file Form
1065-B, U.S. Return of Income for
Electing Large Partnerships. For the rules that
apply to these partnerships, see the Instructions
for Form 1065-B. However, the partners of
electing large partnerships can use the rules in
this publication except as otherwise noted.
Withholding on foreign partner or firm. If a
partnership acquires a U.S. real property inter
est from a foreign person or firm, the partner
ship may have to withhold tax on the amount it
pays for the property (including cash, the fair
market value of other property, and any as
sumed liability). If a partnership has income ef
fectively connected with a trade or business in
the United States, it must withhold on the in
come allocable to its foreign partners. A part
nership may have to withhold tax on a foreign
partner's distributive share of fixed or determi
nable income not effectively connected with a
U.S. trade or business. A partnership that fails
to withhold may be held liable for the tax, appli
cable penalties, and interest.
For more information, see Publication 515,
Withholding of Tax on Nonresident Aliens and
Foreign Entities.
Comments and suggestions. We welcome
your comments about this publication and your
suggestions for future editions.
You can write to:
Internal Revenue Service
Tax Forms and Publications
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clude your daytime phone number, including
the area code, in your correspondence.
You can send us comments from
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mation” and then on “Give us feedback.”
Although we cannot respond individually to
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feedback and will consider your comments as
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Tax questions. If you have a tax question,
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ces tab for more information. We cannot an
swer tax questions at the address listed above.
Ordering forms and publications. Visit
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publications, or write to one of the addresses
shown under How To Get Tax Help in the back
of this publication.
Online payment agreements. Make a
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ient electronic payment options available on
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page of IRS.gov for more information. Deter
mine if you are eligible and submit an Online
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CAUTION
!
Useful Items
You may want to see:
Publication
Tax Guide for Small Business
Tax Withholding and Estimated Tax
Business Expenses
Installment Sales
Accounting Periods and Methods
Sales and Other Dispositions of
Assets
Basis of Assets
Passive Activity and AtRisk Rules
How To Depreciate Property
See How To Get Tax Help near the end of this
publication for information about getting publi
cations and forms.
Forming a Partnership
The following sections contain general informa
tion about partnerships.
Organizations Classified as
Partnerships
An unincorporated organization with two or
more members is generally classified as a part
nership for federal tax purposes if its members
carry on a trade, business, financial operation,
or venture and divide its profits. However, a
joint undertaking merely to share expenses is
not a partnership. For example, coownership of
property maintained and rented or leased is not
a partnership unless the coowners provide
services to the tenants.
The rules you must use to determine
whether an organization is classified as a part
nership changed for organizations formed after
1996.
Organizations formed after 1996. An organi
zation formed after 1996 is classified as a part
nership for federal tax purposes if it has two or
more members and it is none of the following.
An organization formed under a federal or
state law that refers to it as incorporated or
as a corporation, body corporate, or body
politic.
An organization formed under a state law
that refers to it as a jointstock company or
jointstock association.
An insurance company.
Certain banks.
An organization wholly owned by a state,
local, or foreign government.
An organization specifically required to be
taxed as a corporation by the Internal Rev
enue Code (for example, certain publicly
traded partnerships).
Certain foreign organizations identified in
section 301.77012(b)(8) of the regula
tions.
A taxexempt organization.
A real estate investment trust.
334
505
535
537
538
544
551
925
946
An organization classified as a trust under
section 301.77014 of the regulations or
otherwise subject to special treatment un
der the Internal Revenue Code.
Any other organization that elects to be
classified as a corporation by filing Form
8832.
For more information, see the instructions for
Form 8832.
Limited liability company. A limited liabil
ity company (LLC) is an entity formed under
state law by filing articles of organization as an
LLC. Unlike a partnership, none of the members
of an LLC are personally liable for its debts. An
LLC may be classified for federal income tax
purposes as either a partnership, a corporation,
or an entity disregarded as an entity separate
from its owner by applying the rules in Regula
tions section 301.77013. See Form 8832 and
section 301.77013 of the regulations for more
details.
A domestic LLC with at least two
members that doesn't file Form 8832
is classified as a partnership for fed-
eral income tax purposes.
Organizations formed before 1997. An or
ganization formed before 1997 and classified
as a partnership under the old rules will gener
ally continue to be classified as a partnership as
long as the organization has at least two mem
bers and doesn't elect to be classified as a cor
poration by filing Form 8832.
Community property. Spouses who own a
qualified entity (defined below) can choose to
classify the entity as a partnership for federal
tax purposes by filing the appropriate partner
ship tax returns. They can choose to classify
the entity as a sole proprietorship by filing a
Schedule C (Form 1040) listing one spouse as
the sole proprietor. A change in reporting posi
tion will be treated for federal tax purposes as a
conversion of the entity.
A qualified entity is a business entity that
meets all the following requirements.
The business entity is wholly owned by
spouses as community property under the
laws of a state, a foreign country, or a pos
session of the United States.
No person other than one or both spouses
would be considered an owner for federal
tax purposes.
The business entity is not treated as a cor
poration.
For more information about community
property, see Publication 555, Community
Property. Publication 555 discusses the com
munity property laws of Arizona, California,
Idaho, Louisiana, Nevada, New Mexico, Texas,
Washington, and Wisconsin.
Family Partnership
Members of a family can be partners. However,
family members (or any other person) will be
recognized as partners only if one of the follow
ing requirements is met.
If capital is a material incomeproducing
factor, they acquired their capital interest in
a bona fide transaction (even if by gift or
TIP
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Page 2 Publication 541 (January 2016)
purchase from another family member),
actually own the partnership interest, and
actually control the interest.
If capital is not a material incomeproduc
ing factor, they joined together in good
faith to conduct a business. They agreed
that contributions of each entitle them to a
share in the profits, and some capital or
service has been (or is) provided by each
partner.
Capital is material. Capital is a material in
comeproducing factor if a substantial part of
the gross income of the business comes from
the use of capital. Capital is ordinarily an in
comeproducing factor if the operation of the
business requires substantial inventories or in
vestments in plants, machinery, or equipment.
Capital is not material. In general, capital is
not a material incomeproducing factor if the in
come of the business consists principally of
fees, commissions, or other compensation for
personal services performed by members or
employees of the partnership.
Capital interest. A capital interest in a partner
ship is an interest in its assets that is distributa
ble to the owner of the interest in either of the
following situations.
The owner withdraws from the partnership.
The partnership liquidates.
The mere right to share in earnings and prof
its is not a capital interest in the partnership.
Gift of capital interest. If a family member (or
any other person) receives a gift of a capital in
terest in a partnership in which capital is a ma
terial incomeproducing factor, the donee's dis
tributive share of partnership income is subject
to both of the following restrictions.
It must be figured by reducing the partner
ship income by reasonable compensation
for services the donor renders to the part
nership.
The donee's distributive share of partner
ship income attributable to donated capital
must not be proportionately greater than
the donor's distributive share attributable
to the donor's capital.
Purchase. For purposes of determining a
partner's distributive share, an interest pur
chased by one family member from another
family member is considered a gift from the
seller. The fair market value of the purchased
interest is considered donated capital. For this
purpose, members of a family include only
spouses, ancestors, and lineal descendants (or
a trust for the primary benefit of those persons).
Example. A father sold 50% of his business
to his son. The resulting partnership had a profit
of $60,000. Capital is a material incomepro
ducing factor. The father performed services
worth $24,000, which is reasonable compensa
tion, and the son performed no services. The
$24,000 must be allocated to the father as com
pensation. Of the remaining $36,000 of profit
due to capital, at least 50%, or $18,000, must
be allocated to the father since he owns a 50%
capital interest. The son's share of partnership
profit cannot be more than $18,000.
Business owned and operated by spouses.
If spouses carry on a business together and
share in the profits and losses, they may be
partners whether or not they have a formal part
nership agreement. If so, they should report in
come or loss from the business on Form 1065.
They should not report the income on a Sched
ule C (Form 1040) in the name of one spouse
as a sole proprietor. However, the spouses can
elect not to treat the joint venture as a partner
ship by making a Qualified Joint Venture Elec
tion.
Qualified Joint Venture Election. A "qualified
joint venture," whose only members are spou
ses filing a joint return, can elect not to be
treated as a partnership for federal tax purpo
ses. A qualified joint venture conducts a trade
or business where: the only members of the
joint venture are spouses filing jointly; both
spouses elect not to be treated as a partner
ship; both spouses materially participate in the
trade or business (see Passive Activity Limita
tions in the Instructions for Form 1065 for a defi
nition of material participation); and the busi
ness is coowned by both spouses and is not
held in the name of a state law entity such as a
partnership or LLC.
Under this election, a qualified joint venture
conducted by spouses who file a joint return is
not treated as a partnership for federal tax pur
poses and therefore doesn't have a Form 1065
filing requirement. All items of income, gain, de
duction, loss, and credit are divided between
the spouses based on their respective interests
in the venture. Each spouse takes into account
his or her respective share of these items as a
sole proprietor. Each spouse would account for
his or her respective share on the appropriate
form, such as Schedule C (Form 1040). For
purposes of determining net earnings from
selfemployment, each spouse's share of in
come or loss from a qualified joint venture is
taken into account just as it is for federal income
tax purposes (that is, based on their respective
interests in the venture).
If the spouses do not make the election to
treat their respective interests in the joint ven
ture as sole proprietorships, each spouse
should carry his or her share of the partnership
income or loss from Schedule K1 (Form 1065)
to their joint or separate Form(s) 1040. Each
spouse should include his or her respective
share of selfemployment income on a separate
Schedule SE (Form 1040), SelfEmployment
Tax.
This generally doesn't increase the total tax
on the return, but it does give each spouse
credit for social security earnings on which re
tirement benefits are based. However, this may
not be true if either spouse exceeds the social
security tax limitation.
For more information on qualified joint ven
tures, go to IRS.gov, enter “Election for Quali
fied Joint Ventures” in the search box and se
lect the link reading “Election for Husband and
Wife Unincorporated Businesses.”
Partnership Agreement
The partnership agreement includes the original
agreement and any modifications. The modifi
cations must be agreed to by all partners or
adopted in any other manner provided by the
partnership agreement. The agreement or mod
ifications can be oral or written.
Partners can modify the partnership agree
ment for a particular tax year after the close of
the year but not later than the date for filing the
partnership return for that year. This filing date
doesn't include any extension of time.
If the partnership agreement or any modifi
cation is silent on any matter, the provisions of
local law are treated as part of the agreement.
Terminating a
Partnership
A partnership terminates when one of the fol
lowing events takes place.
1. All its operations are discontinued and no
part of any business, financial operation,
or venture is continued by any of its part
ners in a partnership.
2. At least 50% of the total interest in partner
ship capital and profits is sold or ex
changed within a 12month period, includ
ing a sale or exchange to another partner.
Unlike other partnerships, an electing large
partnership doesn't terminate on the sale or ex
change of 50% or more of the partnership inter
ests within a 12month period.
See section 1.7081(b) of the regulations for
more information on the termination of a part
nership. For special rules that apply to a
merger, consolidation, or division of a partner
ship, see sections 1.7081(c) and 1.7081(d) of
the regulations.
Date of termination. The partnership's tax
year ends on the date of termination. For the
event described in (1) above, the date of termi
nation is the date the partnership completes the
winding up of its affairs. For the event described
in (2) above, the date of termination is the date
of the sale or exchange of a partnership interest
that, by itself or together with other sales or ex
changes in the preceding 12 months, transfers
an interest of 50% or more in both capital and
profits.
Short period return. If a partnership is termi
nated before the end of what would otherwise
be its tax year, Form 1065 must be filed for the
short period, which is the period from the begin
ning of the tax year through the date of termina
tion. The return is due the 15th day of the 4th
month (or for tax years beginning after 2015,
the 15th day of the 3rd month) following the date
of termination. See Partnership Return (Form
1065), later, for information about filing Form
1065.
Conversion of partnership into limited lia
bility company (LLC). The conversion of a
partnership into an LLC classified as a partner
ship for federal tax purposes doesn't terminate
the partnership. The conversion is not a sale,
exchange, or liquidation of any partnership in
terest; the partnership's tax year doesn't close;
and the LLC can continue to use the
partnership's taxpayer identification number.
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Publication 541 (January 2016) Page 3
However, the conversion may change some
of the partners' bases in their partnership inter
ests if the partnership has recourse liabilities
that become nonrecourse liabilities. Because
the partners share recourse and nonrecourse li
abilities differently, their bases must be adjus
ted to reflect the new sharing ratios. If a de
crease in a partner's share of liabilities exceeds
the partner's basis, he or she must recognize
gain on the excess. For more information, see
Effect of Partnership Liabilities under Basis of
Partner's Interest, later.
The same rules apply if an LLC classified as
a partnership is converted into a partnership.
IRS e-file (Electronic Filing)
Certain partnerships with more than 100
partners are required to file Form 1065, Sched
ules K1, and related forms and schedules elec
tronically (e-file). Other partnerships generally
have the option to file electronically. For details
about IRS e-file, see the Form 1065 instruc
tions.
Exclusion From
Partnership Rules
Certain partnerships that do not actively con
duct a business can choose to be completely or
partially excluded from being treated as partner
ships for federal income tax purposes. All the
partners must agree to make the choice, and
the partners must be able to figure their own
taxable income without figuring the partner
ship's income. However, the partners are not
exempt from the rule that limits a partner's dis
tributive share of partnership loss to the adjus
ted basis of the partner's partnership interest.
Nor are they exempt from the requirement of a
business purpose for adopting a tax year for the
partnership that differs from its required tax
year.
Investing partnership. An investing partner
ship can be excluded if the participants in the
joint purchase, retention, sale, or exchange of
investment property meet all the following re
quirements.
They own the property as coowners.
They reserve the right separately to take or
dispose of their shares of any property ac
quired or retained.
They do not actively conduct business or
irrevocably authorize some person acting
in a representative capacity to purchase,
sell, or exchange the investment property.
Each separate participant can delegate au
thority to purchase, sell, or exchange his or
her share of the investment property for the
time being for his or her account, but not
for a period of more than a year.
Operating agreement partnership. An oper
ating agreement partnership group can be ex
cluded if the participants in the joint production,
extraction, or use of property meet all the fol
lowing requirements.
They own the property as coowners, ei
ther in fee or under lease or other form of
contract granting exclusive operating
rights.
They reserve the right separately to take in
kind or dispose of their shares of any prop
erty produced, extracted, or used.
They don't jointly sell services or the prop
erty produced or extracted. Each separate
participant can delegate authority to sell
his or her share of the property produced
or extracted for the time being for his or her
account, but not for a period of time in ex
cess of the minimum needs of the industry,
and in no event for more than one year.
However, this exclusion doesn't apply to an un
incorporated organization one of whose princi
pal purposes is cycling, manufacturing, or pro
cessing for persons who are not members of
the organization.
Electing the exclusion. An eligible organiza
tion that wishes to be excluded from the part
nership rules must make the election not later
than the time for filing the partnership return for
the first tax year for which exclusion is desired.
This filing date includes any extension of time.
See Regulations section 1.7612(b) for the pro
cedures to follow.
Partnership Return
(Form 1065)
Every partnership that engages in a trade or
business or has gross income must file an infor
mation return on Form 1065 showing its in
come, deductions, and other required informa
tion. The partnership return must show the
names and addresses of each partner and each
partner's distributive share of taxable income.
The return must be signed by a general partner.
If a limited liability company is treated as a part
nership, it must file Form 1065 and one of its
members must sign the return.
A partnership is not considered to engage in
a trade or business, and is not required to file a
Form 1065, for any tax year in which it neither
receives income nor pays or incurs any expen
ses treated as deductions or credits for federal
income tax purposes.
See the Instructions for Form 1065 for more
information about who must file Form 1065.
Partnership
Distributions
Partnership distributions include the following.
A withdrawal by a partner in anticipation of
the current year's earnings.
A distribution of the current year's or prior
years' earnings not needed for working
capital.
A complete or partial liquidation of a part
ner's interest.
A distribution to all partners in a complete
liquidation of the partnership.
A partnership distribution is not taken into
account in determining the partner's distributive
share of partnership income or loss. If any gain
or loss from the distribution is recognized by the
partner, it must be reported on his or her return
for the tax year in which the distribution is re
ceived. Money or property withdrawn by a part
ner in anticipation of the current year's earnings
is treated as a distribution received on the last
day of the partnership's tax year.
Effect on partner's basis. A partner's adjus
ted basis in his or her partnership interest is de
creased (but not below zero) by the money and
adjusted basis of property distributed to the
partner. See Adjusted Basis under Basis of
Partner's Interest, later.
Effect on partnership. A partnership gener
ally doesn't recognize any gain or loss because
of distributions it makes to partners. The part
nership may be able to elect to adjust the basis
of its undistributed property.
Certain distributions treated as a sale or
exchange. When a partnership distributes the
following items, the distribution may be treated
as a sale or exchange of property rather than a
distribution.
Unrealized receivables or substantially ap
preciated inventory items distributed in ex
change for any part of the partner's interest
in other partnership property, including
money.
Other property (including money) distrib
uted in exchange for any part of a partner's
interest in unrealized receivables or sub
stantially appreciated inventory items.
See Payments for Unrealized Receivables
and Inventory Items under Disposition of Part-
ner's Interest, later.
This treatment doesn't apply to the following
distributions.
A distribution of property to the partner
who contributed the property to the part
nership.
Payments made to a retiring partner or
successor in interest of a deceased part
ner that are the partner's distributive share
of partnership income or guaranteed pay
ments.
Substantially appreciated inventory
items. Inventory items of the partnership are
considered to have appreciated substantially in
value if, at the time of the distribution, their total
fair market value is more than 120% of the part
nership's adjusted basis for the property. How
ever, if a principal purpose for acquiring inven
tory property is to avoid ordinary income
treatment by reducing the appreciation to less
than 120%, that property is excluded.
Partner's Gain or Loss
A partner generally recognizes gain on a part
nership distribution only to the extent any
money (and marketable securities treated as
money) included in the distribution exceeds the
adjusted basis of the partner's interest in the
partnership. Any gain recognized is generally
treated as capital gain from the sale of the part
nership interest on the date of the distribution. If
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Page 4 Publication 541 (January 2016)
partnership property (other than marketable se
curities treated as money) is distributed to a
partner, he or she generally doesn't recognize
any gain until the sale or other disposition of the
property.
For exceptions to these rules, see Distribu-
tion of partner's debt and Net precontribution
gain, later. Also, see Payments for Unrealized
Receivables and Inventory Items under Disposi-
tion of Partner's Interest, later.
Example. The adjusted basis of Jo's part
nership interest is $14,000. She receives a dis
tribution of $8,000 cash and land that has an
adjusted basis of $2,000 and a fair market value
of $3,000. Because the cash received doesn't
exceed the basis of her partnership interest, Jo
doesn't recognize any gain on the distribution.
Any gain on the land will be recognized when
she sells or otherwise disposes of it. The distri
bution decreases the adjusted basis of Jo's
partnership interest to $4,000 [$14,000 −
($8,000 + $2,000)].
Marketable securities treated as money.
Generally, a marketable security distributed to a
partner is treated as money in determining
whether gain is recognized on the distribution.
This treatment, however, doesn't generally ap
ply if that partner contributed the security to the
partnership or an investment partnership made
the distribution to an eligible partner.
The amount treated as money is the securi
ty's fair market value when distributed, reduced
(but not below zero) by the excess (if any) of:
1. The partner's distributive share of the gain
that would be recognized had the partner
ship sold all its marketable securities at
their fair market value immediately before
the transaction resulting in the distribution,
over
2. The partner's distributive share of the gain
that would be recognized had the partner
ship sold all such securities it still held af
ter the distribution at the fair market value
in (1).
For more information, including the defini
tion of marketable securities, see section 731(c)
of the Internal Revenue Code.
Loss on distribution. A partner doesn't recog
nize loss on a partnership distribution unless all
the following requirements are met.
The adjusted basis of the partner's interest
in the partnership exceeds the distribution.
The partner's entire interest in the partner
ship is liquidated.
The distribution is in money, unrealized re
ceivables, or inventory items.
There are exceptions to these general rules.
See the following discussions. Also, see Liqui-
dation at Partner's Retirement or Death under
Disposition of Partner's Interest, later.
Distribution of partner's debt. If a partner
ship acquires a partner's debt and extinguishes
the debt by distributing it to the partner, the
partner will recognize capital gain or loss to the
extent the fair market value of the debt differs
from the basis of the debt (determined under
the rules discussed in Partner's Basis for Dis-
tributed Property, later).
The partner is treated as having satisfied the
debt for its fair market value. If the issue price
(adjusted for any premium or discount) of the
debt exceeds its fair market value when distrib
uted, the partner may have to include the ex
cess amount in income as canceled debt.
Similarly, a deduction may be available to a
corporate partner if the fair market value of the
debt at the time of distribution exceeds its ad
justed issue price.
Net precontribution gain. A partner generally
must recognize gain on the distribution of prop
erty (other than money) if the partner contrib
uted appreciated property to the partnership
during the 7year period before the distribution.
The gain recognized is the lesser of the fol
lowing amounts.
1. The excess of:
a. The fair market value of the property
received in the distribution, over
b. The adjusted basis of the partner's in
terest in the partnership immediately
before the distribution, reduced (but
not below zero) by any money re
ceived in the distribution.
2. The “net precontribution gain” of the part
ner. This is the net gain the partner would
recognize if all the property contributed by
the partner within 7 years of the distribu
tion, and held by the partnership immedi
ately before the distribution, were distrib
uted to another partner, other than a
partner who owns more than 50% of the
partnership. For information about the dis
tribution of contributed property to another
partner, see Contribution of Property, un
der Transactions Between Partnership
and Partners, later.
The character of the gain is determined by
reference to the character of the net precontri
bution gain. This gain is in addition to any gain
the partner must recognize if the money distrib
uted is more than his or her basis in the partner
ship.
For these rules, the term “money” includes
marketable securities treated as money, as dis
cussed earlier under Marketable securities
treated as money.
Effect on basis. The adjusted basis of the
partner's interest in the partnership is increased
by any net precontribution gain recognized by
the partner. Other than for purposes of deter
mining the gain, the increase is treated as oc
curring immediately before the distribution. See
Basis of Partner's Interest, later.
The partnership must adjust its basis in any
property the partner contributed within 7 years
of the distribution to reflect any gain that partner
recognizes under this rule.
Exceptions. Any part of a distribution that
is property the partner previously contributed to
the partnership is not taken into account in de
termining the amount of the excess distribution
or the partner's net precontribution gain. For this
purpose, the partner's previously contributed
property doesn't include a contributed interest
in an entity to the extent its value is due to prop
erty contributed to the entity after the interest
was contributed to the partnership.
Recognition of gain under this rule also
doesn't apply to a distribution of unrealized re
ceivables or substantially appreciated inventory
items if the distribution is treated as a sale or
exchange, as discussed earlier under Certain
distributions treated as a sale or exchange.
Partner's Basis for
Distributed Property
Unless there is a complete liquidation of a part
ner's interest, the basis of property (other than
money) distributed to the partner by a partner
ship is its adjusted basis to the partnership im
mediately before the distribution. However, the
basis of the property to the partner cannot be
more than the adjusted basis of his or her inter
est in the partnership reduced by any money re
ceived in the same transaction.
Example 1. The adjusted basis of Emily's
partnership interest is $30,000. She receives a
distribution of property that has an adjusted ba
sis of $20,000 to the partnership and $4,000 in
cash. Her basis for the property is $20,000.
Example 2. The adjusted basis of Steve's
partnership interest is $10,000. He receives a
distribution of $4,000 cash and property that
has an adjusted basis to the partnership of
$8,000. His basis for the distributed property is
limited to $6,000 ($10,000 − $4,000, the cash
he receives).
Complete liquidation of partner's interest.
The basis of property received in complete liqui
dation of a partner's interest is the adjusted ba
sis of the partner's interest in the partnership re
duced by any money distributed to the partner
in the same transaction.
Partner's holding period. A partner's holding
period for property distributed to the partner in
cludes the period the property was held by the
partnership. If the property was contributed to
the partnership by a partner, then the period it
was held by that partner is also included.
Basis divided among properties. If the basis
of property received is the adjusted basis of the
partner's interest in the partnership (reduced by
money received in the same transaction), it
must be divided among the properties distrib
uted to the partner. For property distributed af
ter August 5, 1997, allocate the basis using the
following rules.
1. Allocate the basis first to unrealized re
ceivables and inventory items included in
the distribution by assigning a basis to
each item equal to the partnership's adjus
ted basis in the item immediately before
the distribution. If the total of these as
signed bases exceeds the allocable basis,
decrease the assigned bases by the
amount of the excess.
2. Allocate any remaining basis to properties
other than unrealized receivables and in
ventory items by assigning a basis to each
property equal to the partnership's
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Publication 541 (January 2016) Page 5
adjusted basis in the property immediately
before the distribution. If the allocable ba
sis exceeds the total of these assigned
bases, increase the assigned bases by the
amount of the excess. If the total of these
assigned bases exceeds the allocable ba
sis, decrease the assigned bases by the
amount of the excess.
Allocating a basis increase. Allocate any
basis increase required in rule (2) above first to
properties with unrealized appreciation to the
extent of the unrealized appreciation. If the ba
sis increase is less than the total unrealized ap
preciation, allocate it among those properties in
proportion to their respective amounts of unre
alized appreciation. Allocate any remaining ba
sis increase among all the properties in propor
tion to their respective fair market values.
Example. Eun's basis in her partnership in
terest is $55,000. In a distribution in liquidation
of her entire interest, she receives properties A
and B, neither of which is inventory or unreal
ized receivables. Property A has an adjusted
basis to the partnership of $5,000 and a fair
market value of $40,000. Property B has an ad
justed basis to the partnership of $10,000 and a
fair market value of $10,000.
To figure her basis in each property, Eun
first assigns bases of $5,000 to property A and
$10,000 to property B (their adjusted bases to
the partnership). This leaves a $40,000 basis
increase (the $55,000 allocable basis minus the
$15,000 total of the assigned bases). She first
allocates $35,000 to property A (its unrealized
appreciation). The remaining $5,000 is alloca
ted between the properties based on their fair
market values. $4,000 ($40,000/$50,000) is al
located to property A and $1,000
($10,000/$50,000) is allocated to property B.
Eun's basis in property A is $44,000 ($5,000 +
$35,000 + $4,000) and her basis in property B
is $11,000 ($10,000 + $1,000).
Allocating a basis decrease. Use the fol
lowing rules to allocate any basis decrease re
quired in rule (1) or rule (2), earlier.
1. Allocate the basis decrease first to items
with unrealized depreciation to the extent
of the unrealized depreciation. If the basis
decrease is less than the total unrealized
depreciation, allocate it among those
items in proportion to their respective
amounts of unrealized depreciation.
2. Allocate any remaining basis decrease
among all the items in proportion to their
respective assigned basis amounts (as
decreased in (1)).
Example. Armando's basis in his partner
ship interest is $20,000. In a distribution in liqui
dation of his entire interest, he receives proper
ties C and D, neither of which is inventory or
unrealized receivables. Property C has an ad
justed basis to the partnership of $15,000 and a
fair market value of $15,000. Property D has an
adjusted basis to the partnership of $15,000
and a fair market value of $5,000.
To figure his basis in each property, Ar
mando first assigns bases of $15,000 to prop
erty C and $15,000 to property D (their adjusted
bases to the partnership). This leaves a
$10,000 basis decrease (the $30,000 total of
the assigned bases minus the $20,000 alloca
ble basis). He allocates the entire $10,000 to
property D (its unrealized depreciation). Arman
do's basis in property C is $15,000 and his ba
sis in property D is $5,000 ($15,000 − $10,000).
Distributions before August 6, 1997. For
property distributed before August 6, 1997, allo
cate the basis using the following rules.
1. Allocate the basis first to unrealized re
ceivables and inventory items included in
the distribution to the extent of the partner
ship's adjusted basis in those items. If the
partnership's adjusted basis in those items
exceeded the allocable basis, allocate the
basis among the items in proportion to
their adjusted bases to the partnership.
2. Allocate any remaining basis to other dis
tributed properties in proportion to their
adjusted bases to the partnership.
Partner's interest more than partnership
basis. If the basis of a partner's interest to be
divided in a complete liquidation of the partner's
interest is more than the partnership's adjusted
basis for the unrealized receivables and inven
tory items distributed, and if no other property is
distributed to which the partner can apply the
remaining basis, the partner has a capital loss
to the extent of the remaining basis of the part
nership interest.
Special adjustment to basis. A partner who
acquired any part of his or her partnership inter
est in a sale or exchange or upon the death of
another partner may be able to choose a spe
cial basis adjustment for property distributed by
the partnership. To choose the special adjust
ment, the partner must have received the distri
bution within 2 years after acquiring the partner
ship interest. Also, the partnership must not
have chosen the optional adjustment to basis
when the partner acquired the partnership inter
est.
If a partner chooses this special basis ad
justment, the partner's basis for the property
distributed is the same as it would have been if
the partnership had chosen the optional adjust
ment to basis. However, this assigned basis is
not reduced by any depletion or depreciation
that would have been allowed or allowable if the
partnership had previously chosen the optional
adjustment.
The choice must be made with the partner's
tax return for the year of the distribution if the
distribution includes any property subject to de
preciation, depletion, or amortization. If the
choice doesn't have to be made for the distribu
tion year, it must be made with the return for the
first year in which the basis of the distributed
property is pertinent in determining the partner's
income tax.
A partner choosing this special basis adjust
ment must attach a statement to his or her tax
return that the partner chooses under section
732(d) of the Internal Revenue Code to adjust
the basis of property received in a distribution.
The statement must show the computation of
the special basis adjustment for the property
distributed and list the properties to which the
adjustment has been allocated.
Example. Chin Ho purchased a 25% inter
est in X partnership for $17,000 cash. At the
time of the purchase, the partnership owned in
ventory having a basis to the partnership of
$14,000 and a fair market value of $16,000.
Thus, $4,000 of the $17,000 he paid was attrib
utable to his share of inventory with a basis to
the partnership of $3,500.
Within 2 years after acquiring his interest,
Chin Ho withdrew from the partnership and for
his entire interest received cash of $1,500, in
ventory with a basis to the partnership of
$3,500, and other property with a basis of
$6,000. The value of the inventory received was
25% of the value of all partnership inventory. (It
is immaterial whether the inventory he received
was on hand when he acquired his interest.)
Since the partnership from which Chin Ho
withdrew didn't make the optional adjustment to
basis, he chose to adjust the basis of the inven
tory received. His share of the partnership's ba
sis for the inventory is increased by $500 (25%
of the $2,000 difference between the $16,000
fair market value of the inventory and its
$14,000 basis to the partnership at the time he
acquired his interest). The adjustment applies
only for purposes of determining his new basis
in the inventory, and not for purposes of part
nership gain or loss on disposition.
The total to be allocated among the proper
ties Chin Ho received in the distribution is
$15,500 ($17,000 basis of his interest − $1,500
cash received). His basis in the inventory items
is $4,000 ($3,500 partnership basis + $500 spe
cial adjustment). The remaining $11,500 is allo
cated to his new basis for the other property he
received.
Mandatory adjustment. A partner doesn't
always have a choice of making this special ad
justment to basis. The special adjustment to ba
sis must be made for a distribution of property
(whether or not within 2 years after the partner
ship interest was acquired) if all the following
conditions existed when the partner received
the partnership interest.
The fair market value of all partnership
property (other than money) was more
than 110% of its adjusted basis to the part
nership.
If there had been a liquidation of the part
ner's interest immediately after it was ac
quired, an allocation of the basis of that in
terest under the general rules (discussed
earlier under Basis divided among proper-
ties.) would have decreased the basis of
property that couldn't be depreciated, de
pleted, or amortized and increased the ba
sis of property that could be.
The optional basis adjustment, if it had
been chosen by the partnership, would
have changed the partner's basis for the
property actually distributed.
Required statement. Generally, if a partner
chooses a special basis adjustment and notifies
the partnership, or if the partnership makes a
distribution for which the special basis adjust
ment is mandatory, the partnership must pro
vide a statement to the partner. The statement
must provide information necessary for the part
ner to figure the special basis adjustment.
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Page 6 Publication 541 (January 2016)
Marketable securities. A partner's basis in
marketable securities received in a partnership
distribution, as determined in the preceding dis
cussions, is increased by any gain recognized
by treating the securities as money. See Mar-
ketable securities treated as money under Part
ner's Gain or Loss, earlier. The basis increase
is allocated among the securities in proportion
to their respective amounts of unrealized appre
ciation before the basis increase.
Transactions Between
Partnership and
Partners
For certain transactions between a partner and
his or her partnership, the partner is treated as
not being a member of the partnership. These
transactions include the following.
1. Performing services for, or transferring
property to, a partnership if:
a. There is a related allocation and distri
bution to a partner; and
b. The entire transaction, when viewed
together, is properly characterized as
occurring between the partnership
and a partner not acting in the ca
pacity of a partner.
2. Transferring money or other property to a
partnership if:
a. There is a related transfer of money or
other property by the partnership to
the contributing partner or another
partner, and
b. The transfers together are properly
characterized as a sale or exchange
of property.
Payments by accrual basis partnership to
cash basis partner. A partnership that uses
an accrual method of accounting cannot deduct
any business expense owed to a cash basis
partner until the amount is paid. However, this
rule doesn't apply to guaranteed payments
made to a partner, which are generally deducti
ble when accrued.
Guaranteed Payments
Guaranteed payments are those made by a
partnership to a partner that are determined
without regard to the partnership's income. A
partnership treats guaranteed payments for
services, or for the use of capital, as if they
were made to a person who is not a partner.
This treatment is for purposes of determining
gross income and deductible business expen
ses only. For other tax purposes, guaranteed
payments are treated as a partner's distributive
share of ordinary income. Guaranteed pay
ments are not subject to income tax withhold
ing.
The partnership generally deducts guaran
teed payments on line 10 of Form 1065 as a
business expense. They are also listed on
Schedules K and K1 of the partnership return.
The individual partner reports guaranteed
payments on Schedule E (Form 1040) as ordi
nary income, along with his or her distributive
share of the partnership's other ordinary in
come.
Guaranteed payments made to partners for
organizing the partnership or syndicating inter
ests in the partnership are capital expenses.
Generally, organizational and syndication ex
penses are not deductible by the partnership.
However, a partnership can elect to deduct a
portion of its organizational expenses and am
ortize the remaining expenses (see Business
start-up and organizational costs in the
Instructions for Form 1065). Organizational ex
penses (if the election is not made) and syndi
cation expenses paid to partners must be repor
ted on the partners' Schedule K1 as
guaranteed payments.
Minimum payment. If a partner is to receive a
minimum payment from the partnership, the
guaranteed payment is the amount by which the
minimum payment is more than the partner's
distributive share of the partnership income be
fore taking into account the guaranteed pay
ment.
Example. Under a partnership agreement,
Divya is to receive 30% of the partnership in
come, but not less than $8,000. The partnership
has net income of $20,000. Divya's share, with
out regard to the minimum guarantee, is $6,000
(30% × $20,000). The guaranteed payment that
can be deducted by the partnership is $2,000
($8,000 − $6,000). Divya's income from the
partnership is $8,000, and the remaining
$12,000 of partnership income will be reported
by the other partners in proportion to their
shares under the partnership agreement.
If the partnership net income had been
$30,000, there would have been no guaranteed
payment since her share, without regard to the
guarantee, would have been greater than the
guarantee.
Selfemployed health insurance premiums.
Premiums for health insurance paid by a part
nership on behalf of a partner, for services as a
partner, are treated as guaranteed payments.
The partnership can deduct the payments as a
business expense, and the partner must include
them in gross income. However, if the partner
ship accounts for insurance paid for a partner
as a reduction in distributions to the partner, the
partnership cannot deduct the premiums.
A partner who qualifies can deduct 100% of
the health insurance premiums paid by the part
nership on his or her behalf as an adjustment to
income. The partner cannot deduct the premi
ums for any calendar month, or part of a month,
in which the partner is eligible to participate in
any subsidized health plan maintained by any
employer of the partner, the partner's spouse,
the partner's dependents, or any children under
age 27 who are not dependents. For more infor
mation on the selfemployed health insurance
deduction, see chapter 6 in Publication 535.
Including payments in partner's income.
Guaranteed payments are included in income in
the partner's tax year in which the partnership's
tax year ends.
Example 1. Under the terms of a partner
ship agreement, Erica is entitled to a fixed an
nual payment of $10,000 without regard to the
income of the partnership. Her distributive
share of the partnership income is 10%. The
partnership has $50,000 of ordinary income af
ter deducting the guaranteed payment. She
must include ordinary income of $15,000
($10,000 guaranteed payment + $5,000
($50,000 × 10%) distributive share) on her indi
vidual income tax return for her tax year in
which the partnership's tax year ends.
Example 2. Lamont is a calendar year tax
payer who is a partner in a partnership. The
partnership uses a fiscal year that ended Janu
ary 31, 2015. Lamont received guaranteed pay
ments from the partnership from February 1,
2014, until December 31, 2014. He must in
clude these guaranteed payments in income for
2015 and report them on his 2015 income tax
return.
Payments resulting in loss. If guaranteed
payments to a partner result in a partnership
loss in which the partner shares, the partner
must report the full amount of the guaranteed
payments as ordinary income. The partner sep
arately takes into account his or her distributive
share of the partnership loss, to the extent of
the adjusted basis of the partner's partnership
interest.
Sale or Exchange
of Property
Special rules apply to a sale or exchange of
property between a partnership and certain per
sons.
Losses. Losses will not be allowed from a sale
or exchange of property (other than an interest
in the partnership) directly or indirectly between
a partnership and a person whose direct or indi
rect interest in the capital or profits of the part
nership is more than 50%.
If the sale or exchange is between two part
nerships in which the same persons directly or
indirectly own more than 50% of the capital or
profits interests in each partnership, no deduc
tion of a loss is allowed.
The basis of each partner's interest in the
partnership is decreased (but not below zero)
by the partner's share of the disallowed loss.
If the purchaser later sells the property, only
the gain realized that is greater than the loss not
allowed will be taxable. If any gain from the sale
of the property is not recognized because of
this rule, the basis of each partner's interest in
the partnership is increased by the partner's
share of that gain.
Gains. Gains are treated as ordinary income in
a sale or exchange of property directly or indi
rectly between a person and a partnership, or
between two partnerships, if both of the follow
ing tests are met.
More than 50% of the capital or profits in
terest in the partnership(s) is directly or in
directly owned by the same person(s).
The property in the hands of the transferee
immediately after the transfer is not a capi
tal asset. Property that is not a capital
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Publication 541 (January 2016) Page 7
asset includes accounts receivable, inven
tory, stockintrade, and depreciable or
real property used in a trade or business.
More than 50% ownership. To determine if
there is more than 50% ownership in partner
ship capital or profits, the following rules apply.
1. An interest directly or indirectly owned by,
or for, a corporation, partnership, estate,
or trust is considered to be owned propor
tionately by, or for, its shareholders, part
ners, or beneficiaries.
2. An individual is considered to own the in
terest directly or indirectly owned by, or
for, the individual's family. For this rule,
“family” includes only brothers, sisters,
halfbrothers, halfsisters, spouses, an
cestors, and lineal descendants.
3. If a person is considered to own an inter
est using rule (1), that person (the “con
structive owner”) is treated as if actually
owning that interest when rules (1) and (2)
are applied. However, if a person is con
sidered to own an interest using rule (2),
that person is not treated as actually own
ing that interest in reapplying rule (2) to
make another person the constructive
owner.
Example. Individuals A and B and Trust T
are equal partners in Partnership ABT. A's hus
band, AH, is the sole beneficiary of Trust T.
Trust T's partnership interest will be attributed
to AH only for the purpose of further attributing
the interest to A. As a result, A is a
morethan50% partner. This means that any
deduction for losses on transactions between
her and ABT will not be allowed, and gain from
property that in the hands of the transferee is
not a capital asset is treated as ordinary, rather
than capital, gain.
More information. For more information on
these special rules, see Sales and Exchanges
Between Related Persons in chapter 2 of Pub.
544.
Contribution of Property
Usually, neither the partner nor the partnership
recognizes a gain or loss when property is con
tributed to the partnership in exchange for a
partnership interest. This applies whether a
partnership is being formed or is already oper
ating. The partnership's holding period for the
property includes the partner's holding period.
The contribution of limited partnership inter
ests in one partnership for limited partnership
interests in another partnership qualifies as a
taxfree contribution of property to the second
partnership if the transaction is made for busi
ness purposes. The exchange is not subject to
the rules explained later under Disposition of
Partner's Interest.
Disguised sales. A contribution of money or
other property to the partnership followed by a
distribution of different property from the part
nership to the partner is treated not as a contri
bution and distribution, but as a sale of prop
erty, if both of the following tests are met.
The distribution wouldn't have been made
but for the contribution.
The partner's right to the distribution
doesn't depend on the success of partner
ship operations.
All facts and circumstances are considered
in determining if the contribution and distribu
tion are more properly characterized as a sale.
However, if the contribution and distribution oc
cur within 2 years of each other, the transfers
are presumed to be a sale unless the facts
clearly indicate that the transfers are not a sale.
If the contribution and distribution occur more
than 2 years apart, the transfers are presumed
not to be a sale unless the facts clearly indicate
that the transfers are a sale.
Form 8275 required. A partner must at
tach Form 8275, Disclosure Statement, (or
other statement) to his or her return if the part
ner contributes property to a partnership and,
within 2 years (before or after the contribution),
the partnership transfers money or other con
sideration to the partner. For exceptions to this
requirement, see section 1.7073(c)(2) of the
regulations.
A partnership must attach Form 8275 (or
other statement) to its return if it distributes
property to a partner, and, within 2 years (be
fore or after the distribution), the partner trans
fers money or other consideration to the part
nership.
Form 8275 must include the following infor
mation.
A caption identifying the statement as a
disclosure under section 707 of the Internal
Revenue Code.
A description of the transferred property or
money, including its value.
A description of any relevant facts in deter
mining if the transfers are properly viewed
as a disguised sale. See section
1.7073(b)(2) of the regulations for a de
scription of the facts and circumstances
considered in determining if the transfers
are a disguised sale.
Contribution to partnership treated as in
vestment company. Gain is recognized when
property is contributed (in exchange for an in
terest in the partnership) to a partnership that
would be treated as an investment company if it
were incorporated.
A partnership is generally treated as an in
vestment company if over 80% of the value of
its assets is held for investment and consists of
certain readily marketable items. These items
include money, stocks and other equity inter
ests in a corporation, and interests in regulated
investment companies and real estate invest
ment trusts. For more information, see section
351(e)(1) of the Internal Revenue Code and the
related regulations. Whether a partnership is
treated as an investment company under this
test is ordinarily determined immediately after
the transfer of property.
This rule applies to limited partnerships and
general partnerships, regardless of whether
they are privately formed or publicly syndicated.
Contribution to foreign partnership. A do
mestic partnership that contributed property af
ter August 5, 1997, to a foreign partnership in
exchange for a partnership interest may have to
file Form 8865 if either of the following apply.
1. Immediately after the contribution, the
partnership owned, directly or indirectly, at
least a 10% interest in the foreign partner
ship.
2. The fair market value of the property con
tributed to the foreign partnership, when
added to other contributions of property
made to the partnership during the pre
ceding 12month period, is greater than
$100,000.
The partnership may also have to file Form
8865, even if no contributions are made during
the tax year, if it owns a 10% or more interest in
a foreign partnership at any time during the
year. See the form instructions for more infor
mation.
Basis of contributed property. If a partner
contributes property to a partnership, the part
nership's basis for determining depreciation,
depletion, gain, or loss for the property is the
same as the partner's adjusted basis for the
property when it was contributed, increased by
any gain recognized by the partner at the time
of contribution.
Allocations to account for builtin gain or
loss. The fair market value of property at the
time it is contributed may be different from the
partner's adjusted basis. The partnership must
allocate among the partners any income, de
duction, gain, or loss on the property in a man
ner that will account for the difference. This rule
also applies to contributions of accounts paya
ble and other accrued but unpaid items of a
cash basis partner.
The partnership can use different allocation
methods for different items of contributed prop
erty. A single reasonable method must be con
sistently applied to each item, and the overall
method or combination of methods must be
reasonable. See section 1.7043 of the regula
tions for allocation methods generally consid
ered reasonable.
If the partnership sells contributed property
and recognizes gain or loss, builtin gain or loss
is allocated to the contributing partner. If con
tributed property is subject to depreciation or
other cost recovery, the allocation of deductions
for these items takes into account builtin gain
or loss on the property. However, the total de
preciation, depletion, gain, or loss allocated to
partners cannot be more than the depreciation
or depletion allowable to the partnership or the
gain or loss realized by the partnership.
Example. Areta and Sofia formed an equal
partnership. Areta contributed $10,000 in cash
to the partnership and Sofia contributed depre
ciable property with a fair market value of
$10,000 and an adjusted basis of $4,000. The
partnership's basis for depreciation is limited to
the adjusted basis of the property in Sofia's
hands, $4,000.
In effect, Areta purchased an undivided
onehalf interest in the depreciable property
with her contribution of $10,000. Assuming that
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Page 8 Publication 541 (January 2016)
the depreciation rate is 10% a year under the
General Depreciation System (GDS), she would
have been entitled to a depreciation deduction
of $500 per year, based on her interest in the
partnership, if the adjusted basis of the property
equaled its fair market value when contributed.
To simplify this example, the depreciation de
ductions are determined without regard to any
firstyear depreciation conventions.
However, since the partnership is allowed
only $400 per year of depreciation (10% of
$4,000), no more than $400 can be allocated
between the partners. The entire $400 must be
allocated to Areta.
Distribution of contributed property to an
other partner. If a partner contributes property
to a partnership and the partnership distributes
the property to another partner within 7 years of
the contribution, the contributing partner must
recognize gain or loss on the distribution.
The recognized gain or loss is the amount
the contributing partner would have recognized
if the property had been sold for its fair market
value when it was distributed. This amount is
the difference between the property's basis and
its fair market value at the time of contribution.
The character of the gain or loss will be the
same as the character of the gain or loss that
would have resulted if the partnership had sold
the property to the distributee partner. Appropri
ate adjustments must be made to the adjusted
basis of the contributing partner's partnership
interest and to the adjusted basis of the prop
erty distributed to reflect the recognized gain or
loss.
Disposition of certain contributed property.
The following rules determine the character of
the partnership's gain or loss on a disposition of
certain types of contributed property.
1. Unrealized receivables. If the property
was an unrealized receivable in the hands
of the contributing partner, any gain or loss
on its disposition by the partnership is or
dinary income or loss. Unrealized receiva
bles are defined later under Payments for
Unrealized Receivables and Inventory
Items. When reading the definition, substi
tute “partner” for “partnership.”
2. Inventory items. If the property was an
inventory item in the hands of the contribu
ting partner, any gain or loss on its dispo
sition by the partnership within 5 years af
ter the contribution is ordinary income or
loss. Inventory items are defined later un
der Payments for Unrealized Receivables
and Inventory Items.
3. Capital loss property. If the property was
a capital asset in the contributing partner's
hands, any loss on its disposition by the
partnership within 5 years after the contri
bution is a capital loss. The capital loss is
limited to the amount by which the part
ner's adjusted basis for the property ex
ceeded the property's fair market value im
mediately before the contribution.
4. Substituted basis property. If the dispo
sition of any of the property listed in (1),
(2), or (3) is a nonrecognition transaction,
these rules apply when the recipient of the
property disposes of any substituted basis
property (other than certain corporate
stock) resulting from the transaction.
Contribution of Services
A partner can acquire an interest in partnership
capital or profits as compensation for services
performed or to be performed.
Capital interest. A capital interest is an inter
est that would give the holder a share of the
proceeds if the partnership's assets were sold
at fair market value and the proceeds were dis
tributed in a complete liquidation of the partner
ship. This determination generally is made at
the time of receipt of the partnership interest.
The fair market value of such an interest re
ceived by a partner as compensation for serv
ices must generally be included in the partner's
gross income in the first tax year in which the
partner can transfer the interest or the interest is
not subject to a substantial risk of forfeiture. The
capital interest transferred as compensation for
services is subject to the rules for restricted
property discussed in Publication 525 under
Employee Compensation.
The fair market value of an interest in part
nership capital transferred to a partner as pay
ment for services to the partnership is a guaran
teed payment, discussed earlier under
Guaranteed Payments.
Profits interest. A profits interest is a partner
ship interest other than a capital interest. If a
person receives a profits interest for providing
services to, or for the benefit of, a partnership in
a partner capacity or in anticipation of being a
partner, the receipt of such an interest is not a
taxable event for the partner or the partnership.
However, this doesn't apply in the following sit
uations.
The profits interest relates to a substan
tially certain and predictable stream of in
come from partnership assets, such as in
come from highquality debt securities or a
highquality net lease.
Within 2 years of receipt, the partner dispo
ses of the profits interest.
The profits interest is a limited partnership
interest in a publicly traded partnership.
A profits interest transferred as compensa
tion for services is not subject to the rules for re
stricted property that apply to capital interests.
Basis of Partner's
Interest
The basis of a partnership interest is the money
plus the adjusted basis of any property the part
ner contributed. If the partner must recognize
gain as a result of the contribution, this gain is
included in the basis of his or her interest. Any
increase in a partner's individual liabilities be
cause of an assumption of partnership liabilities
is considered a contribution of money to the
partnership by the partner.
Interest acquired by gift, etc. If a partner ac
quires an interest in a partnership by gift, inheri
tance, or under any circumstance other than by
a contribution of money or property to the part
nership, the partner's basis must be determined
using the basis rules described in Publication
551.
Adjusted Basis
There is a worksheet for adjusting the
basis of a partner's interest in the part-
nership in the Partner's Instructions for
Schedule K-1 (Form 1065).
The basis of an interest in a partnership is in
creased or decreased by certain items.
Increases. A partner's basis is increased by
the following items.
The partner's additional contributions to
the partnership, including an increased
share of, or assumption of, partnership lia
bilities.
The partner's distributive share of taxable
and nontaxable partnership income.
The partner's distributive share of the ex
cess of the deductions for depletion over
the basis of the depletable property, unless
the property is oil or gas wells whose basis
has been allocated to partners.
Decreases. The partner's basis is decreased
(but never below zero) by the following items.
The money (including a decreased share
of partnership liabilities or an assumption
of the partner's individual liabilities by the
partnership) and adjusted basis of property
distributed to the partner by the partner
ship.
The partner's distributive share of the part
nership losses (including capital losses).
The partner's distributive share of nonde
ductible partnership expenses that are not
capital expenditures. This includes the
partner's share of any section 179 expen
ses, even if the partner cannot deduct the
entire amount on his or her individual in
come tax return.
The partner's deduction for depletion for
any partnership oil and gas wells, up to the
proportionate share of the adjusted basis
of the wells allocated to the partner.
Partner's liabilities assumed by partner-
ship. If contributed property is subject to a debt
or if a partner's liabilities are assumed by the
partnership, the basis of that partner's interest is
reduced (but not below zero) by the liability as
sumed by the other partners. This partner must
reduce his or her basis because the assumption
of the liability is treated as a distribution of
money to that partner. The other partners' as
sumption of the liability is treated as a contribu
tion by them of money to the partnership. See
Effect of Partnership Liabilities, later.
Example 1. Ivan acquired a 20% interest in
a partnership by contributing property that had
an adjusted basis to him of $8,000 and a
$4,000 mortgage. The partnership assumed
payment of the mortgage. The basis of Ivan's
interest is:
TIP
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Publication 541 (January 2016) Page 9
Adjusted basis of contributed property ...... $8,000
Minus: Part of mortgage assumed by other
partners (80% × $4,000) ............... 3,200
Basis of Ivan's partnership interest ........ $4,800
Example 2. If, in Example 1, the contrib
uted property had a $12,000 mortgage, the ba
sis of Ivan's partnership interest would be zero.
The $1,600 difference between the mortgage
assumed by the other partners, $9,600 (80% ×
$12,000), and his basis of $8,000 would be
treated as capital gain from the sale or ex
change of a partnership interest. However, this
gain wouldn't increase the basis of his partner
ship interest.
Book value of partner's interest. The adjus
ted basis of a partner's interest is determined
without considering any amount shown in the
partnership books as a capital, equity, or similar
account.
Example. Enzo contributes to his partner
ship property that has an adjusted basis of $400
and a fair market value of $1,000. His partner
contributes $1,000 cash. While each partner
has increased his capital account by $1,000,
which will be reflected in the partnership books,
the adjusted basis of Enzo's interest is only
$400 and the adjusted basis of his partner's in
terest is $1,000.
When determined. The adjusted basis of a
partner's partnership interest is ordinarily deter
mined at the end of the partnership's tax year.
However, if there has been a sale or exchange
of all or part of the partner's interest or a liquida
tion of his or her entire interest in a partnership,
the adjusted basis is determined on the date of
sale, exchange, or liquidation.
Alternative rule for figuring adjusted basis.
In certain cases, the adjusted basis of a part
nership interest can be figured by using the
partner's share of the adjusted basis of partner
ship property that would be distributed if the
partnership terminated.
This alternative rule can be used in either of
the following situations.
The circumstances are such that the part
ner cannot practicably apply the general
basis rules.
It is, in the opinion of the IRS, reasonable
to conclude that the result produced will
not vary substantially from the result under
the general basis rules.
Adjustments may be necessary in figuring
the adjusted basis of a partnership interest un
der the alternative rule. For example, adjust
ments would be required to include in the part
ner's share of the adjusted basis of partnership
property any significant discrepancies that re
sulted from contributed property, transfers of
partnership interests, or distributions of property
to the partners.
Effect of Partnership
Liabilities
A partner's basis in a partnership interest in
cludes the partner's share of a partnership
liability only if, and to the extent that, the liability:
1. Creates or increases the partnership's ba
sis in any of its assets,
2. Gives rise to a current deduction to the
partnership, or
3. Is a nondeductible, noncapital expense of
the partnership.
The term “assets” in (1) includes capitalized
items allocable to future periods, such as or
ganization expenses.
A partner's share of accrued but unpaid ex
penses or accounts payable of a cash basis
partnership are not included in the adjusted ba
sis of the partner's interest in the partnership.
Partner's basis increased. If a partner's
share of partnership liabilities increases, or a
partner's individual liabilities increase because
he or she assumes partnership liabilities, this in
crease is treated as a contribution of money by
the partner to the partnership.
Partner's basis decreased. If a partner's
share of partnership liabilities decreases, or a
partner's individual liabilities decrease because
the partnership assumes his or her individual li
abilities, this decrease is treated as a distribu
tion of money to the partner by the partnership.
Assumption of liability. Generally, a partner
or related person is considered to assume a
partnership liability only to the extent that:
1. He or she is personally liable for it,
2. The creditor knows that the liability was
assumed by the partner or related person,
3. The creditor can demand payment from
the partner or related person, and
4. No other partner or person related to an
other partner will bear the economic risk of
loss on that liability immediately after the
assumption.
Related person. Related persons, for
these purposes, includes all the following.
An individual and his or her spouse, ances
tors, and lineal descendants.
An individual and a corporation if the indi
vidual directly or indirectly owns 80% or
more in value of the outstanding stock of
the corporation.
Two corporations that are members of the
same controlled group.
A grantor and a fiduciary of any trust.
Fiduciaries of two separate trusts if the
same person is a grantor of both trusts.
A fiduciary and a beneficiary of the same
trust.
A fiduciary and a beneficiary of two sepa
rate trusts if the same person is a grantor
of both trusts.
A fiduciary of a trust and a corporation if
the trust or the grantor of the trust directly
or indirectly owns 80% or more in value of
the outstanding stock of the corporation.
A person and a taxexempt educational or
charitable organization controlled directly
or indirectly by the person or by members
of the person's family.
A corporation and a partnership if the
same persons own 80% or more in value
of the outstanding stock of the corporation
and 80% or more of the capital or profits in
terest in the partnership.
Two S corporations or an S corporation
and a C corporation if the same persons
own 80% or more in value of the outstand
ing stock of each corporation.
An executor and a beneficiary of an estate.
A partnership and a person owning, di
rectly or indirectly, 80% or more of the cap
ital or profits interest in the partnership.
Two partnerships if the same persons di
rectly or indirectly own 80% or more of the
capital or profits interests.
Property subject to a liability. If property
contributed to a partnership by a partner or dis
tributed by the partnership to a partner is sub
ject to a liability, the transferee is treated as
having assumed the liability to the extent it
doesn't exceed the fair market value of the
property.
Partner's share of recourse liabilities. A
partnership liability is a recourse liability to the
extent that any partner or a related person, de
fined earlier under Related person, has an eco
nomic risk of loss for that liability. A partner's
share of a recourse liability equals his or her
economic risk of loss for that liability. A partner
has an economic risk of loss if that partner or a
related person would be obligated (whether by
agreement or law) to make a net payment to the
creditor or a contribution to the partnership with
respect to the liability if the partnership were
constructively liquidated. A partner who is the
creditor for a liability that would otherwise be a
nonrecourse liability of the partnership has an
economic risk of loss in that liability.
Constructive liquidation. Generally, in a
constructive liquidation, the following events are
treated as occurring at the same time.
All partnership liabilities become payable
in full.
All of the partnership's assets have a value
of zero, except for property contributed to
secure a liability.
All property is disposed of by the partner
ship in a fully taxable transaction for no
consideration except relief from liabilities
for which the creditor's right to reimburse
ment is limited solely to one or more assets
of the partnership.
All items of income, gain, loss, or deduc
tion are allocated to the partners.
The partnership liquidates.
Example. Juan and Teresa form a cash ba
sis general partnership with cash contributions
of $20,000 each. Under the partnership agree
ment, they share all partnership profits and los
ses equally. The partnership borrows $60,000
and purchases depreciable business equip
ment. This debt is included in the partners' ba
sis in the partnership because incurring it cre
ates an additional $60,000 of basis in the
partnership's depreciable property.
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Page 10 Publication 541 (January 2016)
If neither partner has an economic risk of
loss in the liability, it is a nonrecourse liability.
Each partner's basis would include his or her
share of the liability, $30,000.
If Teresa is required to pay the creditor if the
partnership defaults, she has an economic risk
of loss in the liability. Her basis in the partner
ship would be $80,000 ($20,000 + $60,000),
while Juan's basis would be $20,000.
Limited partner. A limited partner gener
ally has no obligation to contribute additional
capital to the partnership and therefore doesn't
have an economic risk of loss in partnership re
course liabilities. Thus, absent some other fac
tor, such as the guarantee of a partnership lia
bility by the limited partner or the limited partner
making the loan to the partnership, a limited
partner generally doesn't have a share of part
nership recourse liabilities.
Partner's share of nonrecourse liabilities. A
partnership liability is a nonrecourse liability if
no partner or related person has an economic
risk of loss for that liability. A partner's share of
nonrecourse liabilities is generally proportionate
to his or her share of partnership profits. How
ever, this rule may not apply if the partnership
has taken deductions attributable to nonre
course liabilities or the partnership holds prop
erty that was contributed by a partner.
More information. For more information on
the effect of partnership liabilities, including
rules for limited partners and examples, see
sections 1.7521 through 1.7525 of the regula
tions.
Disposition of
Partner's Interest
The following discussions explain the treatment
of gain or loss from the disposition of an interest
in a partnership.
Abandoned or worthless partnership inter
est. A loss incurred from the abandonment or
worthlessness of a partnership interest is an or
dinary loss only if both of the following tests are
met.
The transaction is not a sale or exchange.
The partner has not received an actual or
deemed distribution from the partnership.
If the partner receives even a de minimis actual
or deemed distribution, the entire loss generally
is a capital loss. However, see Payments for
Unrealized Receivables and Inventory Items,
later.
For information on how to report an aban
donment loss, see the Instructions for Form
4797. See Revenue Ruling 9380 for more in
formation on determining if a loss incurred on
the abandonment or worthlessness of a part
nership interest is a capital or an ordinary loss.
Partnership election to adjust basis of part
nership property. Generally, a partnership's
basis in its assets is not affected by a transfer of
an interest in the partnership, whether by sale
or exchange or because of the death of a part
ner. However, the partnership can elect to
make an optional adjustment to basis in the
year of transfer.
Sale, Exchange,
or Other Transfer
The sale or exchange of a partner's interest in a
partnership usually results in capital gain or
loss. However, see Payments for Unrealized
Receivables and Inventory Items, later, for cer
tain exceptions. Gain or loss is the difference
between the amount realized and the adjusted
basis of the partner's interest in the partnership.
If the selling partner is relieved of any partner
ship liabilities, that partner must include the lia
bility relief as part of the amount realized for his
or her interest.
Example 1. Kumar became a limited part
ner in the ABC Partnership by contributing
$10,000 in cash on the formation of the partner
ship. The adjusted basis of his partnership in
terest at the end of the current year is $20,000,
which includes his $15,000 share of partnership
liabilities. The partnership has no unrealized re
ceivables or inventory items. Kumar sells his in
terest in the partnership for $10,000 in cash. He
had been paid his share of the partnership in
come for the tax year.
Kumar realizes $25,000 from the sale of his
partnership interest ($10,000 cash payment +
$15,000 liability relief). He reports $5,000
($25,000 realized − $20,000 basis) as a capital
gain.
Example 2. The facts are the same as in
Example 1, except that Kumar withdraws from
the partnership when the adjusted basis of his
interest in the partnership is zero. He is consid
ered to have received a distribution of $15,000,
his relief of liability. He reports a capital gain of
$15,000.
Exchange of partnership interests. An ex
change of partnership interests generally
doesn't qualify as a nontaxable exchange of
likekind property. This applies regardless of
whether they are general or limited partnership
interests or interests in the same or different
partnerships. However, under certain circum
stances, such an exchange may be treated as a
taxfree contribution of property to a partner
ship. See Contribution of Property under Trans-
actions Between Partnership and Partners, ear
lier.
An interest in a partnership that has a valid
election in effect under section 761(a) of the In
ternal Revenue Code to be excluded from the
partnership rules of the Code is treated as an
interest in each of the partnership assets and
not as a partnership interest. See Exclusion
From Partnership Rules, earlier.
Installment reporting for sale of partnership
interest. A partner who sells a partnership in
terest at a gain may be able to report the sale
on the installment method. For requirements
and other information on installment sales, see
Publication 537.
Part of the gain from the installment sale
may be allocable to unrealized receivables or
inventory items. See Payments for Unrealized
Receivables and Inventory Items, later. The
gain allocable to unrealized receivables and in
ventory items must be reported in the year of
sale. The gain allocable to the other assets can
be reported under the installment method.
Payments for Unrealized
Receivables and Inventory
Items
If a partner receives money or property in ex
change for any part of a partnership interest, the
amount due to his or her share of the partner
ship's unrealized receivables or inventory items
results in ordinary income or loss. This amount
is treated as if it were received for the sale or
exchange of property that is not a capital asset.
This treatment applies to the unrealized re
ceivables part of payments to a retiring partner
or successor in interest of a deceased partner
only if that part is not treated as paid in ex
change for partnership property. See Liquida-
tion at Partner's Retirement or Death, later.
Unrealized receivables. Unrealized receiva
bles include any rights to payment not already
included in income for the following items.
Goods delivered or to be delivered to the
extent the payment would be treated as re
ceived for property other than a capital as
set.
Services rendered or to be rendered.
These rights must have arisen under a con
tract or agreement that existed at the time of
sale or distribution, even though the partnership
may not be able to enforce payment until a later
date. For example, unrealized receivables in
clude accounts receivable of a cash method
partnership and rights to payment for work or
goods begun but incomplete at the time of the
sale or distribution of the partner's share.
The basis for any unrealized receivables in
cludes all costs or expenses for the receivables
that were paid or accrued but not previously
taken into account under the partnership's
method of accounting.
Other items treated as unrealized receiv-
ables. Unrealized receivables include potential
gain that would be ordinary income if the follow
ing partnership property were sold at its fair
market value on the date of the payment.
Mining property for which exploration ex
penses were deducted.
Stock in a Domestic International Sales
Corporation (DISC).
Certain farm land for which expenses for
soil and water conservation or land clear
ing were deducted.
Franchises, trademarks, or trade names.
Oil, gas, or geothermal property for which
intangible drilling and development costs
were deducted.
Stock of certain controlled foreign corpora
tions.
Market discount bonds and shortterm obli
gations.
Property subject to recapture of deprecia
tion under sections 1245 and 1250 of the
Internal Revenue Code. Depreciation re
capture is discussed in chapter 3 of Publi
cation 544.
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Publication 541 (January 2016) Page 11
Determining gain or loss. The income or
loss realized by a partner upon the sale or ex
change of its interest in unrealized receivables
and inventory items, discussed below, is the
amount that would have been allocated to the
partner if the partnership had sold all of its prop
erty for cash at fair market value, in a fully taxa
ble transaction, immediately prior to the part
ner's transfer of interest in the partnership. Any
gain or loss recognized that is attributable to the
unrealized receivables and inventory items will
be ordinary gain or loss.
Example. You are a partner in ABC Part
nership. The adjusted basis of your partnership
interest at the end of the current year is zero.
Your share of potential ordinary income from
partnership depreciable property is $5,000. The
partnership has no other unrealized receivables
or inventory items. You sell your interest in the
partnership for $10,000 in cash and you report
the entire amount as a gain since your adjusted
basis in the partnership is zero. You report as
ordinary income your $5,000 share of potential
ordinary income from the partnership's depreci
able property. The remaining $5,000 gain is a
capital gain.
Inventory items. Inventory items are not limi
ted to stockintrade of the partnership. They
also include the following property.
Property that would properly be included in
the partnership's inventory if on hand at the
end of the tax year or that is held primarily
for sale to customers in the normal course
of business.
Property that, if sold or exchanged by the
partnership, wouldn't be a capital asset or
section 1231 property (real or depreciable
business property held more than one
year). For example, accounts receivable
acquired for services or from the sale of in
ventory and unrealized receivables are in
ventory items.
Property held by the partnership that would
be considered inventory if held by the part
ner selling the partnership interest or re
ceiving the distribution.
Notification required of partner. If a partner
exchanges a partnership interest attributable to
unrealized receivables or inventory for money
or property, he or she must notify the partner
ship in writing. This must be done within 30
days of the transaction or, if earlier, by January
15 of the calendar year following the calendar
year of the exchange. A partner may be subject
to a $50 penalty for each failure to notify the
partnership about such a transaction, unless
the failure was due to reasonable cause and not
willful neglect.
Information return required of partnership.
When a partnership is notified of an exchange
of partnership interests involving unrealized re
ceivables or inventory items, the partnership
must file Form 8308, Report of a Sale or Ex
change of Certain Partnership Interests. Form
8308 is filed with Form 1065 for the tax year that
includes the last day of the calendar year in
which the exchange took place. If notified of an
exchange after filing Form 1065, the partner
ship must file Form 8308 separately, within 30
days of the notification.
On Form 8308, the partnership provides its
telephone number and states the date of the ex
change and the names, addresses, and tax
payer identification numbers of the partnership
filing the return and the transferee and trans
feror in the exchange. The partnership must
provide a copy of Form 8308 (or a written state
ment with the same information) to each trans
feree and transferor by the later of January 31
following the end of the calendar year or 30
days after it receives notice of the exchange.
The partnership may be subject to a penalty
for each failure to timely file Form 8308 and a
penalty for each failure to furnish a copy of
Form 8308 to a transferor or transferee, unless
the failure is due to reasonable cause and not
willful neglect. If the failure is intentional, a
higher penalty may be imposed. See Internal
Revenue Code sections 6722, 6723, and 6724
for details.
Statement required of partner. If a partner
sells or exchanges any part of an interest in a
partnership having unrealized receivables or in
ventory, he or she must file a statement with his
or her tax return for the year in which the sale or
exchange occurs. The statement must contain
the following information.
The date of the sale or exchange.
The amount of any gain or loss attributable
to the unrealized receivables or inventory.
The amount of any gain or loss attributable
to capital gain or loss on the sale of the
partnership interest.
Partner's disposition of distributed unreal
ized receivables or inventory items. In gen
eral, any gain or loss on a sale or exchange of
unrealized receivables or inventory items a part
ner received in a distribution is an ordinary gain
or loss. For this purpose, inventory items do not
include real or depreciable business property,
even if they are not held more than 1 year.
Example. Oscar, a distributee partner, re
ceived his share of accounts receivable when
his law firm dissolved. The partnership used the
cash method of accounting, so the receivables
had a basis of zero. If Oscar later collects the
receivables or sells them, the amount he re
ceives will be ordinary income.
Exception for inventory items held more
than 5 years. If a distributee partner sells in
ventory items held for more than 5 years after
the distribution, the type of gain or loss depends
on how they are being used on the date sold.
The gain or loss is capital gain or loss if the
property is a capital asset in the partner's hands
at the time sold.
Example. Marucia receives, through disso
lution of her partnership, inventory that has a
basis of $19,000. Within 5 years, she sells the
inventory for $24,000. The $5,000 gain is taxed
as ordinary income. If she had held the inven
tory for more than 5 years, her gain would have
been capital gain, provided the inventory was a
capital asset in her hands at the time of sale.
Substituted basis property. If a distribu
tee partner disposes of unrealized receivables
or inventory items in a nonrecognition transac
tion, ordinary gain or loss treatment applies to a
later disposition of any substituted basis prop
erty resulting from the transaction.
Liquidation at Partner's
Retirement or Death
Payments made by the partnership to a retiring
partner or successor in interest of a deceased
partner in return for the partner's entire interest
in the partnership may have to be allocated be
tween payments in liquidation of the partner's
interest in partnership property and other pay
ments. The partnership's payments include an
assumption of the partner's share of partnership
liabilities treated as a distribution of money.
For income tax purposes, a retiring partner
or successor in interest of a deceased partner is
treated as a partner until his or her interest in
the partnership has been completely liquidated.
Liquidating payments. Payments made in liq
uidation of the interest of a retiring or deceased
partner in exchange for his or her interest in
partnership property are considered a distribu
tion, not a distributive share or guaranteed pay
ment that could give rise to a deduction (or its
equivalent) for the partnership.
Unrealized receivables and goodwill.
Payments made for the retiring or deceased
partner's share of the partnership's unrealized
receivables or goodwill are not treated as made
in exchange for partnership property if both of
the following tests are met.
Capital is not a material incomeproducing
factor for the partnership. Whether capital
is a material incomeproducing factor is ex
plained in the discussion under Family
Partnership near the beginning of this pub
lication.
The retiring or deceased partner was a
general partner in the partnership.
However, this rule doesn't apply to payments
for goodwill to the extent that the partnership
agreement provides for a reasonable payment
to a retiring partner for goodwill.
Unrealized receivables includes, to the ex
tent not previously includible in income under
the method of accounting used by the partner
ship, any rights (contractual or otherwise) to
payment for (1) goods delivered, or to be deliv
ered, to the extent the proceeds therefrom
would be treated as amounts received from the
sale or exchange of property other than a capi
tal asset, or (2) services rendered, or to be ren
dered.
Partners' valuation. Generally, the part
ners' valuation of a partner's interest in partner
ship property in an arm'slength agreement will
be treated as correct. If the valuation reflects
only the partner's net interest in the property (to
tal assets less liabilities), it must be adjusted so
that both the value of, and the basis for, the
partner's interest include the partner's share of
partnership liabilities.
Gain or loss on distribution. Upon the re
ceipt of the distribution, the retiring partner or
successor in interest of a deceased partner will
recognize gain only to the extent that any
money (and marketable securities treated as
money) distributed is more than the partner's
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Page 12 Publication 541 (January 2016)
adjusted basis in the partnership. The partner
will recognize a loss only if the distribution is in
money, unrealized receivables, and inventory
items. No loss is recognized if any other prop
erty is received. See Partner's Gain or Loss un
der Partnership Distributions, earlier.
Other payments. Payments made by the part
nership to a retiring partner or successor in in
terest of a deceased partner that are not made
in exchange for an interest in partnership prop
erty are treated as distributive shares of part
nership income or guaranteed payments. This
rule applies regardless of the time over which
the payments are to be made. It applies to pay
ments made for the partner's share of unreal
ized receivables and goodwill not treated as a
distribution.
If the amount is based on partnership in
come, the payment is taxable as a distributive
share of partnership income. The payment re
tains the same character when reported by the
recipient that it would have had if reported by
the partnership.
If the amount is not based on partnership in
come, it is treated as a guaranteed payment.
The recipient reports guaranteed payments as
ordinary income. For additional information on
guaranteed payments, see Transactions Be-
tween Partnership and Partners, earlier.
These payments are included in income by
the recipient for his or her tax year that includes
the end of the partnership tax year for which the
payments are a distributive share or in which
the partnership is entitled to deduct them as
guaranteed payments.
Former partners who continue to make guar
anteed periodic payments to satisfy the partner
ship's liability to a retired partner after the part
nership is terminated can deduct the payments
as a business expense in the year paid.
Tax Equity and Fiscal
Responsibility Act of
1982 (TEFRA)
TEFRA (Tax Equity and Fiscal Responsibility
Act of 1982) is the common acronym used for a
set of consolidated examination, processing,
and judicial procedures which determine the tax
treatment of partnership items at the partner
ship level for partnerships and limited liability
companies (LLCs) that file as partnerships. TE
FRA created the unified partnership audit and
litigation procedures of Internal Revenue Code
sections 6221 through 6234 (TEFRA partner
ship procedures).
Partnership item. Any item more appro
priately determinable at the partnership level. If
an item is determined to be a partnership item,
all TEFRA rules and procedures apply.
Prior to the enactment of TEFRA, no con
solidated proceeding existed for the tax treat
ment of partnership items at the entity level. As
a result, examination, processing, and judicial
proceedings for partnerships were conducted at
the partner level which required that each part
ner dealt separately with the IRS and the courts.
TEFRA procedures were designed to
streamline examinations of partnerships by re
quiring that partnership issues be handled in a
single, unified partnershiplevel proceeding in
stead of multiple proceedings at the partner
level. TEFRA also created the Tax Matters Part
ner or “TMP” which is the main contact between
the IRS, the partnership, and its partners during
an examination of a partnership. It is important
to note that partners other than the TMP are
also entitled to participate during the examina
tion process and appellate conferences.
For the purposes of these instructions, the
consolidated audit proceedings of Internal Rev
enue Code sections 6221 through 6234 will be
referred to as “TEFRA proceedings.” In addi
tion, partnerships and LLCs that are subject to
the consolidated audit proceedings of Internal
Revenue Code sections 6221 through 6234 will
be referred to as “TEFRA partnerships” and
those partnerships and LLCs that are not sub
ject to the consolidated audit proceedings will
be referred to as “nonTEFRA partnerships.”
Small Partnerships and the
Small Partnership Exception
The term “partnership” means any partnership
required to file a partnership return pursuant to
Internal Revenue Code section 6031. Partner
ships whose tax years begin after September 3,
1982 are TEFRA partnerships unless they meet
the definition of a small partnership found in In
ternal Revenue Code section 6231(a)(1)(B)(i).
This is also commonly referred to as the “Small
Partnership Exception.”
To meet the definition of a small partnership,
the partnership must pass two tests.
1. The partnership must have 10 or fewer
partners at all times during the tax year.
For purposes of the Small Partnership Ex
ception, a married couple filing jointly and
their estates are treated as one partner.
2. All partners must be U.S. persons, resi
dent aliens, C corporations, or estates of
deceased partners. For purposes of the
Small Partnership Exception, a C corpora
tion is any corporation that is not an S cor
poration.
Therefore, a partnership is subject to TE
FRA procedures if during the tax year any part
ner is:
Another partnership;
An S corporation which files Form 1120–S;
An LLC which files a Form 1065, U.S. Re
turn of Partnership Income;
An LLC electing S corporation status;
A single member LLC, commonly referred
to as a “Disregarded Entity” for federal tax
purposes;
A trust, including a grantor trust;
A nominee; or
A nonresident alien individual.
Small Partnership TEFRA
Election
A partnership that meets the definition of a
small partnership may elect to be a TEFRA
partnership by filing Form 8893, Election of
Partnership Level Tax Treatment. Once a valid
TEFRA election is filed, the small partnership is
a TEFRA partnership for the year of the election
and all subsequent tax years unless the election
is revoked with the consent of the IRS. Form
8894, Request to Revoke Partnership Level Tax
Treatment Election, is used by small partner
ships to revoke a prior TEFRA election. If its TE
FRA election is revoked, the small partnership
remains subject to TEFRA for all tax years that
the TEFRA election was in effect including the
year that the election was first filed.
Note. If a partnership doesn't qualify as a
small partnership for the tax year shown on a
TEFRA election revocation, the revocation can
not be made and will not be accepted by the
IRS.
Role of Tax Matters Partner
(TMP) in TEFRA Proceedings
Pursuant to Internal Revenue Code section
6231(a)(7) and Regulations section
301.6231(a)(7)1, the TMP is a general partner
designated by the partnership to represent the
partners during the TEFRA proceedings. The
TMP has special rights and the authority to rep
resent the partners during the TEFRA proceed
ings. The TMP and the TMP's authorized repre
sentative are the only ones that can extend the
Internal Revenue Code section 6229 period of
limitations for making assessments. The TMP
usually selects the forum for litigation of the
partnershiplevel tax dispute: Appeals; U.S. Tax
Court; District Court, in the district of the part
nership's principal place of business; or U.S.
Court of Federal Claims. Notice partners and
notice groups (defined below) are also allowed
to file protests to go to Appeals or petitions to
go to court.
TMPs are designated separately for each
tax year. If a partnership is subject to TEFRA
procedures, it can designate a partner as the
TMP for the tax year for which the return is be
ing filed by completing the Designation of Tax
Matters Partner section of Form 1065.
Note. Since the TMP is a position created
by statute, if the partnership or LLC is nonTE
FRA, it cannot have a TMP.
The TMP can be designated by the partner
ship on the partnership return or at any time af
ter the filing of the partnership return by filing a
statement with the IRS Service Center where
the partnership return was orginally filed. If the
TEFRA partnership is unable or unwilling to
designate a TMP, a TMP can be identified by
using the Largest Profits Interest Rule. The
TMP can also be designated by the IRS or Tax
Court.
Note. Special rules exist for LLCs designat
ing a TMP. See Regulations section
301.6231(a)(7)2 for more information.
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Publication 541 (January 2016) Page 13
A partner may be designated as the TMP of
a partnership for a tax year only if that partner:
1. Was a general partner or managing mem
ber in the partnership or LLC at some time
during the tax year for which designation is
made; or
2. Is a general partner or managing member
in the partnership or LLC as of the time the
designation is made.
For TEFRA purposes, a partner is defined
under Internal Revenue Code sections 761 and
6231(a)(2)(B). State law determines whether
the partner is a general or limited partner and
whether an LLC member is the managing mem
ber. Under the Uniform Limited Partnership Act
(as adopted by most states), a general partner
must have a capital account or contribute serv
ices to the partnership, but need not have an al
location of profit and loss for each year.
Note. If a U.S. person or entity is eligible to
be the TMP, a nonU.S. person or entity cannot
be designated TMP without the consent of the
IRS.
How To Sign Documents on Behalf of the Partnership
The following are examples of how a tax matters partner (TMP) should sign documents on behalf of the partnership. The manner in which the TMP signs depends on whether the TMP is
an entity or an individual. If the TMP is an entity, the individual signs in his or her authority to act on behalf of that entity.
Designated Tax Matters Partner (TMP) Signature as Tax Matters Partner (TMP) Example
Individual Individual's signature John Smith, TMP
S corporation Corporate name followed by the signature and title of the
corporate officer authorized to sign
ABC Inc., TMP, by John Smith, Vice President
C corporation Corporate name followed by the signature and title of the
corporate officer authorized to sign
ABC Inc., TMP, by John Smith, Vice President
Subsidiary of an affiliated group of corporations filing a
consolidated tax return
Subsidiary corporation's name as TMP, followed by the
signature and title of the officer of the subsidiary corporation
authorized to sign
ABCMIlwaukee Incorporated, TMP, by John Smith,
President
Trust (grantor trust) Trust name, followed by the signature and title of the person
authorized to sign on behalf of the trust
Smith Family Trust, TMP, by Joan Smith, Trustee
Limited Liability Company (LLC) without regard to filing
status
LLC name followed by the signature of LLC manager and
title of the manager
LMN LLC, TMP, by John Smith, Manager
Partnership (including limited liability partnerships) whether
or not subject to TEFRA
Partnership name followed by the signature of the person
who has authority under state law to sign for the partnership
(usually, a general partner)
RST Partnership, TMP, by John Smith, General Partner
Notice group. A notice group is a group of
partners in the aggregate having a 5% or more
interest in the profits of a partnership that re
quests and designates one of their members to
receive notices. The designated member of the
notice group is treated as a notice partner.
Notice partner. In partnerships with 100
partners or fewer, all partners are notice part
ners. In a partnership having more than 100
partners, all partners owning at least a 1% inter
est are notice partners. A notice partner is enti
tled to receive notice of the beginning and con
clusion of the TEFRA partnership proceedings.
Statute of Limitations and
TEFRA
There is only one statute of limitations for tax
payers and it is under Internal Revenue Code
section 6501. This code section states that the
period for assessing any tax shall not expire be
fore three years after the later of:
1. The date the taxpayer's return was filed, or
2. The last day for filing the return deter
mined without regard to extensions.
TEFRA created Internal Revenue Code sec
tion 6229 which states that the period for as
sessing any tax attributable to partnership items
(or related affected items, defined below) for a
partnership shall not expire before three years
after the later of:
1. The date the partnership return was filed,
or
2. The last day for filing the partnership re
turn determined without regard to exten
sions.
Note. The Internal Revenue Code section
6229 period of limitations for making assess
ments extends, but cannot shorten, the Internal
Revenue Code section 6501 statute. It is the
partners' periods of assessment that are exten
ded by this provision.
Affected item. A special nonpartnership
item that is affected by a partnership item.
Amended Returns and
Administrative Adjustment
Requests (AARs)
Administrative adjustment requests are also
known as requests for administrative adjust
ment (RAAs). AARs are amended returns filed
either by the TMP on behalf of the entire part
nership (partnershiplevel AAR) or by a partner
(partnerlevel AAR) requesting an administra
tive adjustment to correct a partnership item re
ported on the partner's income tax return. Part
nershiplevel AARs are filed on Form 1065X,
Amended Return or Administrative Adjustment
Request (AAR), unless the partnership files
electronically. Partnershiplevel AARs filed
electronically and partnerlevel AARs are filed
using Form 8082, Notice of Inconsistent Treat
ment or Administrative Adjustment Request.
For more information on filing AARs, see the In
structions for Forms 1065X and 8082.
Note. A passthrough entity that is a partner
in a TEFRA partnership cannot file an AAR. For
example, if a partner in a TEFRA partnership is
itself a partnership, the passthrough entity that
is a partner cannot file an AAR for partnership
items originating from the TEFRA partnership.
How To Get Tax Help
Go online, use a smart phone, call, or walk in to
an office near you. Whether it's help with a tax
issue, preparing your tax return or picking up a
free publication or form, get the help you need
the way you want it.
Internet. IRS.gov and IRS2Go are
ready when you are — every day, ev
ery night, 24 hours a day, 7 days a
week.
Apply for an Employer Identification Num
ber (EIN). Go to IRS.gov and enter Apply
for an EIN in the search box.
Request an Electronic Filing PIN by going
to IRS.gov and entering Electronic Filing
PIN in the search box.
Check the status of your amended return.
Go to IRS.gov and enter Where's My
Amended Return in the search box.
Download forms, instructions, and publica
tions, including some accessible versions.
Order free transcripts of your tax returns or
tax account using the Order a Transcript
tool on IRS.gov or IRS2Go. Tax return and
tax account transcripts are generally avail
able for the current year and past three
years.
Locate the nearest Taxpayer Assistance
Center using the Office Locator tool on
IRS.gov or IRS2Go. Stop by most busi
ness days for facetoface tax help, no ap
pointment necessary — just walk in. An
employee can explain IRS letters, request
adjustments to your tax account, or help
you set up a payment plan. Before you
visit, check the Office Locator for the ad
dress, phone number, hours of operation,
and the services provided. If you have an
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Page 14 Publication 541 (January 2016)
ongoing tax account problem or a special
need, such as a disability, you can request
an appointment. Call the local number lis
ted in the Office Locator, or look in the
phone book under United States Govern-
ment, Internal Revenue Service.
Research your tax questions at
www.irs.gov/uac/Tax-Law-Questions.
Search publications and instructions by
topic or keyword.
Read the Internal Revenue Code, regula
tions, or other official guidance.
Read Internal Revenue Bulletins.
Sign up to receive local and national tax
news by email.
Phone. You can call the IRS, or you
can carry it in your pocket with the
IRS2Go app on your smart phone or
tablet.
Download the free IRS2Go mobile app
from the iTunes app store or from Google
Play. Use it to watch the IRS YouTube
channel, get IRS news as soon as it's re
leased to the public, order transcripts of
your tax returns or tax account, check your
refund status, subscribe to filing season
updates or daily tax tips, and follow the IRS
Twitter news feed, @IRSnews, to get the
latest federal tax news, including informa
tion about tax law changes and important
IRS programs.
Call the Amended Return Hotline,
18664642050, to check the status of
your amended return.
Call to order forms, instructions and publi-
cations, 1800TAXFORM
(18008293676) to order currentyear
forms, instructions and publications, and
prioryear forms and instructions (limited to
5 years). You should receive your order
within 10 business days.
Walkin. You can find a selection of
forms, publications, and services —
inperson, facetoface.
Products. You can walk in to some post of
fices, libraries, and IRS offices to pick up
certain forms, instructions, and publica
tions. Some IRS offices, libraries, and city
and county government offices have a col
lection of products available to photocopy
from reproducible proofs.
Mail. You can send your order for
forms, instructions, and publications to
the address below. You should re
ceive a response within 10 business days after
your request is received.
Internal Revenue Service
1201 N. Mitsubishi Motorway
Bloomington, IL 617056613
The Taxpayer Advocate Service. The Tax
payer Advocate Service (TAS) is your voice at
the IRS. The TAS's job is to ensure that every
taxpayer is treated fairly, and that you know and
understand your rights. The TAS offers free
help to guide you through the oftenconfusing
process of resolving tax problems that you
haven't been able to solve on your own. Re
member, the worst thing you can do is nothing
at all.
As a taxpayer, you have rights that the IRS
must abide by in its dealings with you. The TAS
online tax toolkit at
www.TaxpayerAdvocate.irs.gov can help you
understand these rights.
If you think the TAS might be able to help
you, call your local advocate, whose number is
in your phone book and on our website at
www.irs.gov/advocate. You can also call our
tollfree number at 18777774778.
The TAS also handles largescale or sys
temic problems that affect many taxpayers. If
you know of one of these broad issues, please
report it to us through our Systemic Advocacy
Management System at www.irs.gov/sams.
To help us develop a more useful index, please let us know if you have ideas for index entries.
See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.
Index
A
Administrative adjustment
requests 14
Allocations:
Builtin gain or loss 8
Installment sale 11
Amended returns 14
Assistance (See Tax help)
B
Builtin gain or loss 8
C
Capital interest 3, 9
C corporation, TEFRA 13
Comments on publication 2
Contribution:
Basis of property 8
Builtin gain or loss 8
Distribution of property 9
Net precontribution gain 5
Property 8
Services 9
D
Definition, partnership 2
Determining ownership 8
Distributions:
Gain or loss 4
Partner's debt 5
Partnership 4
Distributive share:
Adjusted basis 9
Guaranteed payments 7
E
efile 4
Electronic filing 4
F
Family partnership 2
Form:
8275 8
8308 12
8832 2
8865 8
G
Guaranteed payments 7
H
How to sign documents on
behalf of the partnership 14
I
Insurance, selfemployed
health 7
Inventory items, substantially
appreciated 4
L
Liability:
Assumption of 10
Partner's assumed by
partnership 9
Partnership's 10
Limited liability company 2
Liquidation:
Constructive 10
Partner's interest 5
Partner's retirement or death 12
Losses:
Sales or exchanges 7
M
Marketable securities 5
N
Notice group, TEFRA 14
Notice partner, TEFRA 14
P
Partner's:
Basis:
Distributed property 5
Partnership interest 9
Interest:
Acquired by gift 9
Alternative rule, adjusted
basis 10
Basis 9
Basis adjustments 9
Book value 10
Liquidation of 5, 12
Mandatory basis
adjustment 6
Sale, exchange, transfer 11
Special basis adjustment 6
Transactions with partnership 7
Partnership:
Abandoned or worthless
interest 11
Agreement 3
Basis, contributed property 8
Capital interest 3
Defined 2
Exclusion from rules 4
Family 2
Forming 2
Liabilities 10
Terminating 3
Transactions with partner 7
Partnership item, TEFRA 13
Precontribution gain 5
Profits interest 9
Publications (See Tax help)
R
Related person 10
S
Selfemployed health
insurance 7
Short period return 3
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Publication 541 (January 2016) Page 15
Small partnership exception to
TEFRA 13
Statute of Limitations and
TEFRA 14
Substantially appreciated
inventory items 4
Suggestions for publication 2
T
Tax help 14
Tax matters partner 13
Tax withholding, foreign person
or firm 2
TEFRA 13
Terminating a partnership 3
TTY/TDD information 14 U
Uniform Limited Partnership ACT
(ULPA) 14
Unrealized receivables 11
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