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1: Two Types of Partnership Distributions
There are generally two types of distributions a partnership can make to its partners: liquidating and non-liquidating. The distinction between the two is whether the person remains a partner in the partnership after the distribution.
A liquidating distribution occurs when either the partnership itself liquidates and distributes all of its property to the partners, or when the partnership remains ongoing and one of its partners redeems all their interest.
A non-liquidating distribution is any distribution to a continuing partner from an on-going partnership.
2: Non-Liquidating Partnership Distribution can be a draw or a partial liquidation
Within non-liquidating partnership distributions there are two variations: a draw; and a partially liquidating distribution. A draw is a distribution of a partner’s share of current or accumulated earnings. On the other hand, a partial liquidation will reduce a partner’s interest in the partnership but does not liquidate the partner’s interest.
3: Partnership Distributions May be Proportionate to Partnership Interest
Distributions made to partners may or may not be in proportion to their interest in the partnership. In general, when a proportionate distribution is made neither the partnership nor the partner will recognize gain or loss on non-liquidating distributions. Keep in mind, distributions should be distinguished from allocations of income to partners, which can result in a taxable event notwithstanding a distribution.
When a distribution is made, the partner’s adjusted basis in the partnership is decreased by the amount of money or property distributed. But it can’t go below zero. The partner would only recognize gain or loss on the distribution when the amount exceeds the adjusted basis of the partner’s interest. Any gain recognized is typically treated as capital gain from the sale. If property is distributed, the partner would only recognize the gain when the property is sold.
A disproportionate distribution occurs when a partner receives cash or property that increases or decreases the partner’s share of ordinary income producing assets.
These so-called hot assets include substantially appreciated inventory or unrealized receivables. When this occurs the distribution is treated as a taxable sale or exchange of that property between the partner and the partnership.