AICPA Representative Tasks (verbatim). 1. Application: Calculate the allocation of partnership income (loss) after the sale of a partner's share in a partnership for tax purposes. 2. Application: Calculate the revised basis of partnership assets due to a transfer of a partnership interest for tax purposes.
Partnership ownership changes trigger two distinct compliance issues: (1) how to split the year's income between the departing and incoming partners, and (2) whether to adjust the partnership's asset basis to match what the new partner paid. Mastering both calculations is essential for partnership tax compliance.
When a partner transfers their entire interest during the tax year, §706(d) requires the partnership to allocate income between the transferor (seller) and transferee (buyer). The partnership agreement may specify either of two methods.
KEY: The proration method is simpler but may misallocate income if results vary significantly across the year. The interim closing method reflects economic reality but requires additional bookkeeping.
Common mistakes
- Applying proration to extraordinary items. Gains from asset sales, §1231 transactions, and capital contributions must use the interim closing method even when the partnership otherwise uses proration. Trap: "prorate the $200,000 equipment sale gain across all days." Correct: allocate entirely to the period when the sale occurred.
- Forgetting to add assumed liabilities to outside basis. The purchase price alone understates outside basis when the partnership has liabilities. Trap: "outside basis equals cash paid." Correct: outside basis equals cash paid plus the transferee's share of partnership liabilities.
- Treating §743(b) adjustment as partnership-wide. The adjustment is personal to the transferee and tracked separately. Trap: "partnership adjusts its books for all partners." Correct: only the transferee's share of depreciation and gain is affected.
Bottom line
- When a partner sells their interest mid-year, partnership income must be allocated between seller and buyer using either the interim closing method or the proration method under §706(d)
- The proration method allocates annual income ratably by days; the interim closing method closes the books on the transfer date and allocates actual results to each period
- Extraordinary items such as asset sales, §1231 gains, and capital contributions cannot be prorated and require interim closing for that item
- A §754 election allows the partnership to adjust the inside basis of its assets to reflect the purchase price paid by the transferee partner under §743(b)
Exam shortcut
"Days Held ÷ 365" for proration questions. Count the seller's days from January 1 through the day before transfer; count the buyer's days from transfer date through December 31. Multiply each by the partner's ownership percentage and annual income to get the allocation. "Outside minus Inside = Adjustment" for §743(b). Calculate outside basis (purchase price + liabilities), subtract proportionate inside basis, and the difference is the adjustment.
The full lesson (about 2,717 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.C4
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