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his/her partnership interest, rather than the basis of the property received in the distribution. Any effect on the basis of the distributed property will be indirect.¶20,051 REDUCTIONS IN THE DISTRIBUTEE-PARTNER’S SHARE OF PARTNERSHIPDEBTMany distributions, other than of the partners’ shares of partnership profits, will change the partners’ continuing interests in the partnership. For example, if one partner withdraws a portion of his/her invested capital, his/her remaining investment in the partnership is reduced relative to that of the other partners. In effect, the distributee-partner has reduced his/her investment in future partnership operations, and will generally be entitled to a smaller share of future profits and losses from the partnership.EXAMPLE 20.20 Last year, Wilson, Tim and Jill each invested $100,000 in a new partnership. Each partner received a one-third interest in partnership profits, losses and capital. In the partnership’s first year of operations, it generated a 12 percent return on equity, reporting net income of $36,000 ($300,000 capital invested by the partners times 12 percent). At the beginning of the second year, Wilson decided to withdraw half of his net capital investment, or $56,000 (his net capital investment prior to the withdrawal was $112,000, consisting of his $100,000 initial contribution, plus his one-third share of the partnership’s $36,000 Year 1 income). If the partnership continues to earn a 12 percent return on equity, its Year 2 income will be $33,600 (remaining capital of $280,000 times 12 percent). Recall that at the beginning of Year 2, Wilson reduced his capital investment in the partnership by half, to $56,000. In contrast, Tim and Jill left their entire $112,000 investment in the partnership. Thus, Wilson is now only a twenty percent partner ($56,000 divided by total capital of $280,000). Accordingly, his share of the partnership’s Year 2 income should be only one-fifth, or $6,720, rather than one third. Note that this share gives Wilson a 12 percent return on his reduced capital investment in the partnership ($56,000 times .12 equals $6,720).Reflecting the distributee-partner’s reduced share of future partnership profits and losses, his/her share of partnership liabilities should be similarly reduced. Under Code Sec. 752(b), a reduction in the partner’s share of partnership liabilities is treated as a cash distribution, and must be accounted for in addition to the rest of the distribution. In some cases, the liability relief will trigger recognition of gain by the partner. In most cases, however, it will simply result in a
smaller basis in either the distributed property or in the partner’s remaining interest in the partnership.EXAMPLE 20.21 Prior to January, Jody was a one-third partner in the JFK Partnership. Her basis in her partnership interest was $45,000, consisting of her $15,000 contribution to partnership capital and her $30,000 (one-third) share of partnership liabilities. In January, the partnership distributed $30,000 cash to Jody in complete liquidation of her interest in the partnership. Because Jody must account for both the $30,000 direct cash distribution, and the $30,000 decrease in her share of partnership liabilities, her total distribution is effectively $60,000. Moreover, the entire amount is treated as a cash