In any successful family business there will likely come a time when descendants will want to take over the business from the older generation of owners. Usually, this will require that entities will need to be split into different business entities to accommodate both differences between the descendants (perhaps the descendants can’t cooperate with each other) or managing risk, so that high risk business can be separated from lower risk businesses and investments (construction business needs to be separated from investment assets such as stocks, bonds, annuity assets.)
In restructuring businesses that are partnerships, the restructuring may be made taxable restructures or non-tax restructures. A mere liquidation of a partnership that distributes assets or liabilities, or both, and then a formation of one or more partnerships will likely incur an income tax at the partner level. However, there is a procedure that would make this transaction nontaxable if requirements are met.
There are two main partnership restructuring procedures which are usually called “Assets Up” and “Assets Over” and a third seldom used is the “Interest Over.” The “Assets Over” procedure generally yields no taxable income and is therefore usually the default form of partnership merger, whenever the form of the merger does not specifically follow the assets-up form, as it usually provides favorable tax treatment for taxpayers and the government. It generally will follow state law procedures and none of the partners actually own the partnerships’ assets.
The “Assets Over” form distributes assets to its partners which is then contributes these assets to a recipient partnership. These transfers are likely to trigger taxable income, among other unpleasant collateral consequences. Also, inside and outside basis in the transferred assets can be difficult to ascertain, especially if there are liabilities involved. It is difficult to see why the parties would want to use this form, unless there are significant increases in the basis of partnership assets, most likely because partners had purchased interest when there was no §754 elections (adjusting inside basis for a purchase of a partnership interest) in effect.
If the instead the partners contribute their partnership interests into another partnership (Interest Over), the IRS may restructure the transaction as an “Assets Over” form.
All of these transactions have complicated collateral consequences regarding inside and outside basis, depreciation recapture, liabilities and asset step up or step down. When partners transfer their interest to a corporation (“Interests Up Form”) and the result is a mixture of the two preceding partnership merger theories. Competent and experienced counsel must be consulted.
Have a question? Contact Brett Thompson. Your comments are always welcome!