Question

Andrews, Badin, and Carr formed a partnership, ABC. During Year 2, the partnership sold some land that was held for investment and generated a long-term capital gain. How will this income be reported on the partners' individual tax returns?

a. The income will retain its character and be reported as a long-term capital gain.

b. The income will be combined with the profit generated by the partnership and flow through to the partners as ordinary income.

c. The partnership will pay the tax due on the long-term capital gain rather than allocate it to the partners.

d. The income will be reported on the partners' individual tax returns only if they receive the proceeds from the sale.

Answer 1

Income from a partnership's sale of investment land, classified as a long-term capital gain, retains its character and is reported as such on the individual tax returns of the partners. Partnerships themselves do not pay taxes but act as pass-through entities, where income and gains pass through to partners' personal tax filings.

Step-by-step explanation:

When a partnership like ABC sells an asset held for investment and realizes a long-term capital gain, this income retains its character when reported on the partners' individual tax returns. This means that the correct answer is that the income will retain its character and be reported as a long-term capital gain. Unlike corporations, a partnership is not subject to taxation at the business level. Instead, partnerships are "pass-through" entities, which means that income, deductions, gains, losses, and credits pass through to the partners who then report these on their individual tax returns in accordance with their share of the partnership.

Each partner's share of the capital gain will be reported on Schedule D (Capital Gains and Losses) and Form 8949 if required, which are part of the individual tax return (Form 1040). The nature of the income is not converted to ordinary income; it maintains its original classification as per the Internal Revenue Code. This treatment of income aligns with the flexibility advantage offered in partnerships, allowing partners to benefit from various forms of income and tax treatments.

Taxes are allocated to each partner based on their ownership interest or agreement within the partnership. Therefore, each partner includes this gain in their tax filings and pays the appropriate tax, taking advantage of the favorable long-term capital gains rates as applicable.