You previously learned about the tax effects of proportionate non liquidating distributions, also known as operating or current distributions. These occur when a partner receives a pro rata share of income producing assets, as specified by the partnership agreement, and a distribution that does not terminate the interests of a partner or the partnership entity itself. In other words, in a non-liquidating operating distribution, the partnership continues to exist, and the partner continues to hold an interest in the partnership after the distribution is made. In contrast, this lesson considers the tax implications of proportionate liquidating distributions, which consist of one or more distributions that result in termination of a partner's entire interest in the partnership. This situation can arise in a couple of ways. First, if a partner wishes to terminate their interests and the other remaining partners do not have the means or desire to purchase the terminating interests, the partnership agreement often allows the partnership to close out the terminating interests. Second, all partners might agree to liquidate the entire partnership, perhaps due to continued unprofitability. In such cases the partnership might distribute all of its assets to the partners in complete liquidation, much like a complete corporate liquidation. Overall, there are two main tax issues for partnerships in the case of liquidating distributions. First, does the terminating partner recognize a gain or loss on the distribution? Second, how does the terminating partner reallocate their entire outside basis to the distributed assets? In short, the tax treatment for liquidating distributions involves replacing the partner's entire outside basis, with the partnership assets distributed to the partner. In a perfect world, there should be no gain or loss recognize, and the asset bases should be the same to the terminating partner as they were to the partnership. But as you know, tax life is really that simple. Consequently, Congress created different sets of rules to determine gain or loss and allocate the partner's outside basis to the assets received in a liquidating distribution. To examine the liquidating distribution rules, this lesson is comprised of several parts, many more than normal. The goal is to keep the concepts compartmentalized, which will make them easier to understand and learn especially the first time you encounter them. After examining each concept, you will apply them to SunChaser Shakery before examining a new concept. It will likely be helpful to review this less than a couple of times. Liquidating distributions are not incredibly complicated, per se, but their tax treatment does involve many steps. In a Subchapter C world, Section 336 provides that gain or loss shall be recognized to a liquidating corporation on the distribution of property and complete liquidation as of such property were sold to the distributee at its fair market value. Similarly, the shareholder level tax treatment of complete liquidations is governed by section 331. Gain or loss to shareholders and corporate liquidations. Subsection A states that amounts received by a shareholder in a distribution and complete liquidation of the corporation shall be treated as in full payment in exchange for the stock. In other words, sale or exchange tax treatment applies to both the corporation and the shareholder. However, in Subchapter K, Section 731 provides that in general, neither the partner, nor the partnership recognize gain or loss when the partnership liquidates. Why are the tax treatments of liquidations between corporations and partnerships exactly the opposite when the result is the same? Liquidation. The answer, of course, is the aggregate and entity of legal concepts. As you have seen several times now, the aggregate concept governs most of the general partnership rules, while entity concepts govern most of the corporate general rules. Let's return to the general rule. As noted in general, neither partnership nor partners recognize a gain or loss from liquidating distributions. However, there are, of course, some exceptions to this general rule. In particular, similar to an operating distribution, a terminating partner will recognize gain if money and access of outside basis is received in the distribution. Unlike an operating distribution, a partner can recognize a loss from a liquidating distribution, but only if two conditions are met. First, the partner must only receive cash or hot assets, that is unrealized receivables and inventory, and distribution of any other property prevents any loss recognition. Second, the partner's outside bases exceeds the partnerships inside bases of the distributed assets. Any loss recognized is capital in character. Finally, recall from operating distributions that any reduction in a partner share of partnership debt is considered a distribution of money to the partner which ultimately reduces the outside basis available for allocation to other assets including hot assets.