Optional Basis Adjustments Under Subchapter K: Trap for the Unwary, Tax Planning Tool, or Both? Should They Be Mandatory?

Abstract

The optional basis adjustments of Subchapter K have occupied a prominent position in tax planning and partnership operations for the past 60 years. In the dispositional context, the general approach of the Code to the taxation of partnerships and their partners treats the partnership as an entity, separate and distinct from its partners. Thus, if a partner disposes of his partnership interest by sale to a third party, no adjustment or modification of the bases of the assets of the partnership occurs. Such is the case even though ownership of the partnership has been altered and the purchase price for the interest reflects the fair market value of the partner's underlying share of the partnership assets. Similarly, if a partner's interest is liquidated by the partnership, although the value of the distributed assets equals that of the relinquished partnership interest, the bases of the partnership's remaining assets are unaffected. Thus, in the case of a disposition by sale or liquidation for cash of an appreciated partnership interest, although the seller/distributee is taxed on the gain, without a basis adjustment, the purchaser or the remaining partners will be taxed on the same gain when realized by the partnership. In a similar fashion, for a depreciated partnership interest, a "duplication of loss" will arise, i.e., at both the partner and the partnership level.