Question

28. Marvin Bridges is a 25 percent partner in the Munson partnership. On November 23, 2017, Marvin contributes property with an adjusted basis of $75,000 and a fair market value of $250,000 to the Munson partnership. On March 15, 2018, Marvin receives a $187,500 cash distribution from the partnership.

1. Why would the IRS seek to classify the transactions as a disguised sale?

2. Assume that the IRS is successful in classifying the transactions as a disguised sale. Outline the income tax consequences to Marvin.

Answer 1

Answer:-

Generally, in a partnership firm, a partner can contribute his property towards his capital contribution, the tax gain arising from which is not taxable

However, this practice is misused by most of the partners to evade the taxation. Hence, IRS proposed to revise the guidelines to arrest such practices.

Under the new rules, property transactions between partners and partnerships are to be classified as disguised sales and, therefore, subject to taxes, particularly when the partner concerned receives any disproportionate disbursemets from the firm within 2 years of transfer.

In this case, mr. Marvin contributes his property having FMV of $2.5 lacs with adjusted basisof $75k. Within 4 months of transfer, he gets cash distribution of $187500 from the firm, which is much above the adjusted basis. Hence, IRS would surely seek explanation as to why it should not regard the transaction as a disguised sale.

b) If the transaction is classified as a disguised sale, the transaction hitherto exempted from tax in the hands of Marvin is now becomes taxable.

The tax liability for Marvin is arrived as follows;

FMV as on date of transaction: $250,000 Less: adjusted basis $75000. Taxable gain: $250,000-$75000=$175000

The other partners are unaffected by this transaction.