Mr. and Ms. Smith's partnership owns the following assets: Mr. and Ms. Smith each have a basis for their partnership interest of $135,000. Calculate their combined recognized gain or loss and classify it as capital or ordinary if they sell their partnership interests for $500,000.
A) $230,000 ordinary income.
B) $230,000 capital gain.
C) $115,000 ordinary income and $115,000 capital gain.
D) $110,000 ordinary income and $120,000 capital gain.
E) None of the above.

Question

Mr. and Ms. Smith's partnership owns the following assets:  Mr. and Ms. Smith each have a basis for their partnership interest of $135,000. Calculate their combined recognized gain or loss and classify it as capital or ordinary if they sell their partnership interests for $500,000.
A) $230,000 ordinary income. 
B) $230,000 capital gain. 
C) $115,000 ordinary income and $115,000 capital gain. 
D) $110,000 ordinary income and $120,000 capital gain. 
E) None of the above.

Quizplus · Accepted Answer

The partners' combined basis in the partnership is $270,000 ($135,000 + $135,000), and the sale price is $500,000, so the recognized gain is $230,000 ($500,000 - $270,000). Since the partnership assets are not held primarily for sale to customers in the ordinary course of business, the gain is classified as capital. However, since the partners' basis is different from the sale price, the gain is also partially ordinary income under the rules of Section 751. The portion of the gain classified as ordinary income is equal to the lesser of the partners' gain as if all the partnership assets had been sold at fair market value ($250,000) or the excess of the partners' share of the unrealized receivables and inventory items over their basis ($115,000). Therefore, the answer is D, $110,000 ordinary income and $120,000 capital gain.

Mr and Ms Smith's Partnership Owns the Following Assets: Mr