Have a Tax Question? Ask a Tax Expert
Hello,Thank you for using justanswer. I can assist you with your questions today.
Generally speaking, a partnership interest is a capital asset, thus any sale of the interest could potentially give rise to capital gain or loss. However, tax partners who contemplate the sale of their equity interests should closely examine the underlying assets of the partnership. If the partnership is holding hot assets, i.e., certain assets that would give rise to ordinary income if sold by the partnership, the sale of the partner's interest in the partnership can give rise to ordinary income.
What would the character of gain of a sale in a partnership interest with the only asset being a contractual right to purchase property under a purchase and sale agreement? - It would really depend on what the underlying property is. Is it ordinary income property like inventory, or is it investment assets? If it were an investment asset then it would be capital and the sale of the partnership interest would give rise to capital gain or loss. I am 80% sure that the contractual right itself is not an ordinary asset and this will give rise to capital gain or loss. You would also have to consider the business purpose of the partnership. If it is a holding company it is pretty hard to say that it would have any ordinary assets if it does not actively manage anything...
Would the sale of the partnership be considered an "unrealized receivable" under Section 751? - No section 751 is referring to hot assets, as mentioned above. These are things like unrealized working company receivables or certain inventory items.
What you may have to be mindful of is IRC 704(c). This is basically saying that if you were not originally a partner when the partnership acquired the contractual right to purchase asset then you will most likely not receive an allocation of it's income or loss, whether or not it was sold on the date of the partnership disposition. 704(c) is kind of tricky but if you were a partner in the partnership on the date of acquiring the asset then there should be no issues.
IRC 704 - http://www.law.cornell.edu/uscode/text/26/704
Please let me know if you have any further questions.
Let me give you some more details which might help. The purchase and sale agreement is a contract to buy land. The partnership will also obtain county entitlements to build on the land, however they will not actually build on it. Therefore, they will be selling partnership interest with the contractual right to purchase land and build on the land.
With that in mind, would the contractual right be considered a "hot asset" under §751?
Clearly capital. The sale of the partnership interest would be a capital asset giving rise to capital gain/loss. There is nothing "ordinary" about this transaction.
Whether or not an asset is a capital asset depends not only on the item, but the use of the item.
Almost everything owned and used for personal or investment purposes is a capital asset. An interest is a partnership is an investment, much like a stock or bond.
The tax code actually defines or lists what is not a capital asset (rather than saying what is a capital asset) That is, all but the items on the list are capital assets.
"Any property you own is a capital asset, except the following noncapital assets.
Property held mainly for sale to customers or property that will physically become a part of the merchandise for sale to customers.
Depreciable property used in your trade or business, even if fully depreciated.
Real property used in your trade or business.
A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property that is:
Created by your personal efforts,
Prepared or produced for you (in the case of a letter, memorandum, or similar property), or
Acquired under circumstances (for example, by gift) entitling you to the basis of the person who created the property or whom it was prepared or produced.
Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered or from the sale of property described in (1).
U.S. Government publications that you received from the government free or for less than the normal sales price, or that you acquired under circumstances entitling you to the basis of someone who received the publications free or for less than the normal sales price.
Certain commodities derivative financial instruments held by commodities derivatives dealers. For more information, see section 1221 of the Internal Revenue Code.
Hedging transactions, but only if the transaction is clearly identified as a hedging transaction before the close of the day on which it was acquired, originated, or entered into.
Supplies of a type you regularly use or consume in the ordinary course of your trade or business
The contract rights or entitlements are not a receivable. A receivable is tied to an obligation to be paid. Rights or options to form a contract are not tied to such an obligation.
Sale of the partnership interest (and sale of only the underlying asset or property consisting only of rights) would be sale of a capital asset since it is not one of the nine items listed that are not capital assets.
Please ask if you need clarification.
If the purchase and sale agreement contains the contractual right to acquire land AND has entitlements to build houses on the land (that would and could be sold at a later date), would that be considered a non-capital asset ( real property? #3 on the list you provided) or an unrealized receivable?
"If the purchase and sale agreement contains the contractual right to acquire land AND has entitlements to build houses on the land (that would and could be sold at a later date), would that be considered a non-capital asset ( real property? #3 on the list you provided) or an unrealized receivable? "
No it is not.
This is not a receivable. This is ownership of a set of rights. A receivable is an amount of money or property due from individuals and companies. Owning the right to purchase, develop or do something is not a receivable.
The right to buy the property is not the same as the property. Just as a mortgage is not real property, neither is the right to buy real property. Real property is the actual land or items attached to the land and not the rights or obligations that can be attached to the real property.
Please do ask if you need more clarification.
The language in the code of what are unrealized receivables is at http://www.law.cornell.edu/uscode/text/26/751
"c) Unrealized receivables
For purposes of this subchapter, the term "unrealized receivables" includes, to the extent not previously includible in income under the method of accounting used by the partnership, any rights (contractual or otherwise) to payment for-
(1) goods delivered, or to be delivered, to the extent the proceeds therefrom would be treated as amounts received from the sale or exchange of property other than a capital asset, or
(2) services rendered, or to be rendered. "
Note that these are any rights (contractual or otherwise) to payment for goods or services and not rights (contractual or otherwise) to purchase. Receivables are the right to get the money from a sale not the right to give the money in a purchase.
Hope this helps clarify for you.