Sale Of Partnership Interest

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IRS Practice Unit Focuses On Sale Of A Partnership Interest

It is a little known secret that IRS Large Business & International (“LB&I”) issues “Practice Units” from time to time. Often, these Practice Units are worth a read because they “are developed through internal collaboration and serve as both job aids and training materials . . . [to IRS examiners] on tax issues.” A list of former Practice Units can be found here.

Recently, on March 12, 2021, IRS LB&I issued a 50-page Practice Unit on the “Sale of a Partnership Interest.” This Insight discusses that Practice Unit.

General Concepts.

Subchapter K of the Internal Revenue Code (“Code”) houses the partnership tax rules. Under these complex rules, a partnership is generally not a taxable entity—rather, the items from the partnership flow through and are reported by the partners on their respective income tax returns. In this manner, a partnership is not treated as a separate entity but instead is treated more as an aggregate of its partners. For federal tax purposes, this is known as the “aggregate theory” of partnership taxation.

Written by Matthew Roberts | Posted in IRS Examination Focus

Jason Freeman on Sale or Exchange On Partnership Interests

When a partner enters into a sale or exchange of their partnership interest, there are often lurking tax surprises—such as unexpected phantom income triggers. Sales of partnership interests are notoriously fraught with potential tax traps for the unwary. It is, in fact, even possible to trigger more tax on a sale than one receives in exchange for the interest in the partnership.

One of the more common lurking issues involves triggering income from so-called “hot assets,” often in the form of “unrealized receivables” held by the partnership. The scope of “unrealized receivables” is deceptively wide, and can include partnership attributes such as depreciation recapture, mining property, and a host of other items.

Moreover, to add insult to injury, the Code provides that “recapture income” is not eligible for installment method reporting. Thus, where a partnership interest is sold in exchange for payments over time, part of all of the transaction may not qualify for installment method reporting, requiring that the income related to the “recapture income” be reported immediately (i.e., as phantom income if the reporting of the income does not match the actual receipt of the payments).
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