Annie is a 30 percent partner in the Sunny Partnership and has decided to terminate her partnership interest. Annie is considering two options as potential exit strategies.
1. The first is to have Sunny liquidate Annie’s partnership interest with a proportionate distribution of $374,000 worth of the following assets: cash of $242,000, accounts receivable (basis $0, FMV $12,000) and inventory (basis $74,000, FMV $120,000). Annie will also have debt relief equal to $66,000, her share of the partnership liabilities.
2. The second option is for Annie to sell her partnership interest to the two remaining partners, Gail and Bart for $374,000 cash.
Immediately before either option, Annie’s basis in her partnership interest is $334,000, including her share of partnership liabilities of $66,000. Sunny reports the following assets as of the termination date:
Tax Basis FMV
Assets:
Cash $ 390,000 $ 390,000
Accounts Receivable 0 40,000
Inventory 240,000 400,000
Investments 60,000 105,000
Building 90,000 100,000
Land used in business 160,000 430,000
Total $ 940,000 $1,465,000
Required:
a. What are the tax consequences (amount and character of recognized gain or loss, basis in assets) for Annie under each option?
b. If Annie chooses option 1, what is the amount and character of her gain when she eventually sells the accounts receivable and inventory she receives in the distribution (assume she sells them for fair market value).
c. Which option would you choose and why?