August 28, 2015
Dennis Pellecchia, Partner-in-Charge, Needham Office, Featured in New England Real Estate Journal Article, "Deductability of Payment Made in Redemption of a Recalcitrant Partner's Interest, Arising in Connection With a Dispute."
Q: Can any part of a payment, or payments, made to settle a partners' dispute, including the redemption of a recalcitrant partner's interest, provide an ordinary current deduction for the remaining partners?
A: Yes, if the transaction is structured, and respected, as a redemption. Section 736 of the Internal Revenue Code provides that distributions made by a partnership in liquidation of a partner's interest in a partnership are categorized either as Section 736(a) payments or Section 736(b) payments. Section 736(b) payments are "payments for partnership property". Absent an agreement between the parties as to how much of the payments are Section 736(b) payments with respect to partnership property, the entire amount of such payments will be characterized as Section 736(b) payments. Generally, as long as adverse parties agree on how much of the payments are Section 736(b) payments, the balance will be characterized as Section 736(a) payments. Section 736(a) payments are treated either as the redeemed partner's "distributive share", under Section 736(a)(1), or as guaranteed payments pursuant to Section 736(a)(2), if determined without regard to partnership income. Section 736(a)(1) payments reduce the amount of partnership income that would otherwise be allocated to the remaining partners, while Section 736(a)(2) payments are deductible by the partnership.
However, while Section 736 applies to distributions made in redemption of a partner's interest, it does not apply to a purchase and sale of a partner's interest. In a transaction characterized as a purchase and sale of a partner's interest 100% of the consideration paid would be considered to be paid with respect to the acquisition of the selling partner's interest. Therefore, none of the payments would be currently deductible. If a Section 754 election is in effect then the purchasing partner, or partners, would be able to avail themselves of a Section 743(b) adjustment ("basis step-up"), generally equal to the amount by which the total consideration paid exceeds the selling partner's share of the partnership's basis in the "property". However, such an adjustment, to the extent properly allocable to depreciable property, must be depreciated over a newly assigned useful life of the "property."