9073 / What are the tax consequences of a charitable contribution of partnership interests?

A partnership interest is a capital asset that, if sold, would be given capital gain or loss treatment except to the extent of the partner’s share of certain partnership property that, if sold by the partnership, would produce ordinary gain (i.e., the partner’s share of “unrealized receivables” and “substantially appreciated inventory”).¹ (See Q 8605 and Q 8606 regarding the treatment of capital gains and losses.) Thus, if a taxpayer makes a charitable contribution of a partnership interest, and if the taxpayer has held the interest for long enough to qualify for long-term capital gain treatment (i.e., more than one year, see Q 8625), a deduction is permitted in the amount of the full fair market value of the interest less the amount of ordinary gain, if any, that would have been realized by the partnership for the partnership’s share of “unrealized receivables” and “substantially appreciated inventory.” (The deduction is subject to the otherwise applicable limits discussed in Q 9065.)

If the partnership interest includes a liability (mortgage, etc.), the amount of the liability is treated as an amount realized on the disposition of the partnership interest.² Thus, the contribution is subject to the bargain sale rules, and the transfer will be treated, in part at least, as a sale (see Q 9069).³ (If the partner’s share of the partnership liabilities exceeds the fair market value of his partnership interest, the partner may have taxable income, but no deduction under the bargain sale rules.) In Goodman v. United States,⁴ the taxpayer contributed her partnership interest to charity, subject to her share of partnership debt. The district court held that the taxpayer recognized gain on the transfer that was equal to the excess of the amount realized over that portion of the adjusted basis of the partnership interest (at the time of the transfer) allocable to the sale under IRC Section 1011(b).⁵

The following steps must be taken to determine the taxpayer’s taxable income and the amount of the charitable deduction under the bargain sale rules: |

1. Determine the taxable gain on the sale portion. Under the bargain sale rules, part of the donor’s basis is allocated to the portion sold. The basis allocated to the sold portion is the amount of basis that bears the same ratio to the entire basis as the amount realized bears to the market value of the property. Presumably, the sold portion includes the same proportionate part of the donor’s share of unrealized receivables and substantially appreciated inventory as it does basis.

Example: Adam owns a 10 percent interest in a partnership that he has held for three years. The fair market value of his interest is $100,000 and his adjusted basis is $50,000. His share of a mortgage on partnership property is $40,000, and his share of “unrealized receivables” (potential depreciation recapture on the mortgaged property) is $5,000 in which the partnership’s basis is zero. He donates his entire interest to charity. He is deemed to have received $40,000, his share of partnership liabilities, on the transfer. In effect there are two transactions–a sale for $40,000 and a contribution of $60,000.

Of Adam’s $50,000 basis in his partnership interest, $20,000 is allocated to the sale portion: $40,000 (amount realized)/$100,000 (fair market value) × $50,000 (total adjusted basis). The fair market value of the sold portion is $40,000 (amount realized). Adam must recognize a gain of $20,000 ($40,000 realized less $20,000 adjusted basis allocated to the sold portion). Of that gain, $2,000 is allocable to unrealized receivables ($5,000 unrealized receivables × $40,000/$100,000). Because the partnership has no basis in the unrealized receivables, the entire $2,000 would be ordinary income. Adam must report a taxable long-term capital gain of $18,000 and a taxable ordinary gain of $2,000.

2. Determine the charitable contribution deduction. Generally, the fair market value of the portion given to charity is deductible except to the extent the property would have generated ordinary income if sold. Consequently, the allowable deduction for the gift portion must be reduced to the extent the portion of the partnership interest given to the charity would produce ordinary income if sold.

Example: The fair market value of Adam’s gift to charity is $60,000. Because 60 percent of the partnership interest was given to the charity ($60,000/$100,000), 60 percent of Adam’s share of partnership “unrealized receivables,” or $3,000 ($5,000 × 60 percent = $3,000), is considered included in the gift. The balance of the gift would be long-term capital gain on sale. Because $3,000 would be ordinary income on a sale, Adam’s contribution is reduced by $3,000, and his charitable contribution deduction is $57,000.