Question

As a general rule, the partner has a Capital gain or loss when transferring a partnership interest because a partnership interest is a Capital Asset. The requirement is to determine the amount of ordinary income that Carr should report on the sale of his partnership interest. Although the sale of a partnership interest generally results in capital gain or loss, ordinary income must be recognized to the extent of the selling partner's share of unrealized receivables and appreciated inventory. For example, Carr must report ordinary income to the extent of his 1/3 share of the unrealized accounts receivable of 420,000/3, or 140,000.

Answer 1

Carr must report ordinary income of $140,000 from the sale of his partnership interest, representing his share of unrealized receivables. This treatment is required to reflect the immediate revenue potential of such assets and ensure appropriate tax categorization. The remainder of his gain may be considered capital gain, but the specified amount is subject to ordinary income tax rates.

Step-by-step explanation:

The sale of a partnership interest typically results in a capital gain or loss for the partner, but it also requires the recognition of ordinary income under certain conditions. Specifically, when a partner sells their interest in a partnership, they must recognize ordinary income to the extent that their share of unrealized receivables and appreciated inventory is present in the partnership's assets. In the case of Carr, he must report ordinary income equivalent to his one-third share of the partnership's unrealized accounts receivable, resulting in a reportable ordinary income of $140,000 (420,000/3).

In partnerships, such receivables and inventory can often reflect the potential for immediate revenue if they were liquidated or sold, and as such, the Internal Revenue Service (IRS) treats the income as ordinary. The implication for Carr in the context of this business transaction is that while the remainder of his gain from the sale of the partnership interest might be treated as capital gain, subject to different tax rates and conditions, the specified $140,000 needs to be treated as ordinary income, which is typically taxed at a higher rate. This treatment aligns with the tax code's attempt to prevent partners from converting what would otherwise be ordinary income into a more favorable capital gains taxation scenario.