Rule Atlas
IRC § 751: Sale of a Partnership Interest: Navigating Hot Assets and Basis Adjustments
Under IRC § 751 (IRS / Treasury Circular 230), sale of a Partnership Interest: Navigating Hot Assets and Basis Adjustments establishes the authoritative rules tested on the IRS Enrolled Agent (EA). Master the calculation of gain or loss on the sale of a partnership interest, the critical distinction between capital gain and ordinary income due to 'hot assets' under IRC §751, and, verified against VoraPrep's IRS Enrolled Agent (EA) blueprint.
Worked Example: Sale of Interest with Hot Assets
| Asset | Adjusted Basis | Fair Market Value |
|---|---|---|
| Cash | $30,000 | $30,000 |
| Accounts Receivable | $0 | $60,000 |
| Inventory | $90,000 | $120,000 |
| Capital Asset (Land) | $30,000 | $60,000 |
| Total | $150,000 | $270,000 |
Chloe sells her one-third interest in Granite Peak Partners to David. At the time of the sale, the partnership has not made a Section 754 election. The partnership's assets have a total adjusted basis of $2,000,000 and a fair market value of $1,720,000. A mandatory basis adjustment under IRC §743 is required because the partnership has a substantial built-in loss. A substantial built-in loss exists when the partnership's adjusted basis in its property exceeds the fair market value of the property by more than what amount?
Worked Example: Sale of Interest with Hot Assets
Scenario. Carla is a 1/3 partner in the ABC Partnership, which uses the cash method. She sells her entire interest to David for $90,000 cash. Carla's outside basis is $50,000. The partnership has no liabilities. The partnership's balance sheet shows the following assets:
- | Asset | Adjusted Basis | Fair Market Value | |---|---|---| | Cash | $30,000 | $30,000 | | Accounts Receivable | $0 | $60,000 | | Inventory | $90,000 | $120,000 | | Capital Asset (Land) | $30,000 | $60,000 | | Total | $150,000 | $270,000 |
- Let's calculate Carla's gain and its character.
- Step 1: Calculate Total Gain Amount Realized: $90,000 (Cash received) + $0 (Share of liabilities) = $90,000 Adjusted Outside Basis: $50,000 Total Gain Recognized: $90,000 − $50,000 = $40,000
- Step 2: Identify and Quantify Sec. 751 Hot Assets Unrealized Receivables: The partnership has $60,000 of accounts receivable with a $0 basis. This creates $60,000 of potential ordinary income. Substantially Appreciated Inventory: The inventory's FMV ($120,000) is greater than 120% of its adjusted basis (120% x $90,000 = $108,000). Therefore, it is a hot asset. This creates $30,000 of potential ordinary income ($120,000 FMV - $90,000 basis). Total potential ordinary income from hot assets = $60,000 (A/R) + $30,000 (Inventory) = $90,000.
Common IRS Enrolled Agent (EA) Distractors on IRC § 751
- 1Every question on the sale of a partnership interest follows the same underlying structure. Use this 5-step decision framework and you'll rarely miss one:
- 2Step 3. Calculate the Total Gain or Loss. This is simply the Amount Realized from Step 1 minus the adjusted outside basis from Step 2. This total gain is the number you will split between ordinary and capital character in the next steps.
- 3Unrealized Receivables: Rights to payment for goods or services that have not yet been included in the partnership's income. This is common in cash-basis partnerships. It also includes potential depreciation recapture under §1245 and §1250.
- 4Think of the mnemonic URI to remember the two main categories of hot assets that trigger ordinary income:
Frequently Asked Questions: IRC § 751
What is the core rule under IRC § 751 (Sale of a Partnership Interest: Navigating Hot Assets and Basis Adjustments)?
Under IRC § 751 (IRS / Treasury Circular 230), sale of a Partnership Interest: Navigating Hot Assets and Basis Adjustments establishes the authoritative rules tested on the IRS Enrolled Agent (EA). Master the calculation of gain or loss on the sale of a partnership interest, the critical distinction between capital gain and ordinary income due to 'hot assets' under IRC §751, and, verified against VoraPrep's IRS Enrolled Agent (EA) blueprint.
How is IRC § 751 tested on the IRS Enrolled Agent (EA)?
Every question on the sale of a partnership interest follows the same underlying structure. Use this 5-step decision framework and you'll rarely miss one: Step 3. Calculate the Total Gain or Loss. This is simply the Amount Realized from Step 1 minus the adjusted outside basis from Step 2. This total gain is the number you will split between ordinary and capital character in the next steps.
Where can I practice IRS Enrolled Agent (EA) questions on Sale of a Partnership Interest: Navigating Hot Assets and Basis Adjustments?
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