When a partner receives more than a proportionate share of hot assets in a distribution, the transaction is treated as though the partnership distributes a proportionate share of cold assets to the partner and then the partner sells some or allof those cold assets back to the partnership at fair market value in exchange for a portion of the hot assets actually received in the distribution.

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This is known as the "substitute basis rule" under Section 732(d) of the Internal Revenue Code. It applies when a partner receives a disproportionate share of hot assets (such as unrealized receivables or inventory items with built-in gain) in a distribution from the partnership. The rule deems the partner to have received a proportionate share of cold assets (such as cash, marketable securities, or depreciable property) and then to have sold those cold assets back to the partnership at fair market value in exchange for a portion of the hot assets actually received. This allows the partnership to allocate the built-in gain or income associated with the hot assets to the partner who received them, rather than burdening the other partners who did not benefit from the distribution.

When a Partner Receives More Than a Proportionate Share of Hot