Distributions Subject to Section 737

Understanding Distributions Subject to Section 737

Section 737 of the Internal Revenue Code addresses specific tax implications related to distributions made by partnerships. This section is particularly relevant when a partner receives a distribution of property that has appreciated in value, which can lead to tax consequences that differ from standard distributions. This article aims to clarify the mechanics of Section 737, its implications for partners, and the adjustments necessary for determining the excess distribution.

Overview of Section 737

Section 737 applies when a partner receives a distribution from a partnership that includes property subject to a built-in gain. This section is designed to prevent partners from avoiding tax liabilities by transferring appreciated property out of the partnership. The key aspect of Section 737 is the concept of "excess distributions," which occur when the value of the distributed property exceeds the partner's adjusted tax basis in their partnership interest.

Determining Excess Distributions

To determine the amount of excess distribution, it is essential to calculate the partner's adjusted tax basis in the partnership interest. This basis includes any adjustments resulting from prior distributions, particularly those subject to Section 737. The following factors are critical in this calculation:

1. Adjusted Tax Basis: The partner's adjusted tax basis must account for any basis adjustments due to prior distributions or transactions that are part of the same distribution.
2. Section 754 Election: If the partnership has made a Section 754 election, the basis adjustments under Section 734(b)(1)(A) must be considered. This election allows for adjustments to the basis of partnership property upon the transfer of a partnership interest.
3. Net Precontribution Gain: For the purposes of Section 737, the net precontribution gain is reduced by any basis adjustments made to Section 704(c) property contributed by the distributee partner.

Implications for Partners

Partners must be aware of the implications of receiving distributions subject to Section 737. The excess distribution can lead to immediate tax liabilities, as the partner may recognize gain to the extent that the distribution exceeds their adjusted tax basis. This recognition of gain can complicate tax planning and necessitate careful consideration of the timing and nature of distributions.

Example Scenario

Consider a partnership where Partner A has an adjusted tax basis of $50,000 in their partnership interest. The partnership distributes property valued at $80,000, which has a basis of $30,000. In this case, the excess distribution would be calculated as follows:

1. Value of the distribution: $80,000
2. Adjusted tax basis: $50,000
3. Excess distribution: $80,000 - $50,000 = $30,000

Partner A would recognize a gain of $30,000, which is the amount by which the distribution exceeds their adjusted tax basis.

Conclusion

Understanding the provisions of Section 737 is crucial for partners in a partnership, particularly when it comes to tax planning and compliance. The determination of excess distributions requires careful calculation of the adjusted tax basis and consideration of any applicable basis adjustments. Partners should consult with tax professionals to navigate the complexities associated with these distributions and to ensure compliance with tax regulations.