Page 523 - TaxAdviser_2022

Taxpayers sometimes think that they will be able to realize the passive
activity losses by making a gift of the PTP interest. However, gifting
the units will not allow the losses to be recognized currently.

attached to the PTP’s Schedule K-1. The donor will recognize gain if the in some gain recognition on the transfer.
For example, in the situation illustrated amount of liabilities assumed by the This is not what most people would
in the table “Ordinary Income Re- donee exceeds the transferor’s basis in expect — it is not the same as giving
capture” on p. 38 the individual thinks the units (including liabilities). At least publicly traded stock.
she has a capital gain from the sale the gain can be offset by a PAL of the For example, say a client wants to gift
of her 50,000 PTP units of $175,000 same amount. PTP units he has held for over one year
($200,000 proceeds less $25,000 basis). The investor’s death: There are with an FMV of $40,000 and a basis of
She assumes the tax on the sale is similar problems with unrealized PALs $25,000 (including $10,000 of allocated
$35,000, based on a 20% preferential at the investor’s death. If income is never debt). The amount of the gift in this
capital gain rate (ignoring for this ex- realized to offset the limited losses, then instance would be $40,000, the actual
ample the 3.8% net investment income upon death, the PALs are recognized FMV of the interest, or 80% of the value
tax and state taxes). What she might on the investor’s final tax return to of the assets on a lookthrough basis
not realize is that $100,000 of the gain the extent that the losses exceed the ($40,000 gift ÷ $50,000 total gross FMV
is related to recapture property. This difference between the date-of-death of assets). The amount realized on the
results in ordinary income rather than fair market value (FMV) and the $10,000 of debt relief is then reduced
capital gain for that portion. If the investor’s basis prior to death (the step- by an allocation of basis of $5,000 (20%
taxpayer’s ordinary income tax rate is up in basis). If the PALs do not exceed (ratio of debt relief to FMV of assets) ×
37%, this means that the total tax on the step-up in basis, they are lost and basis of $25,000). As a result, the client
the sale is $52,000 ([$100,000 × 37%] + never provide a tax benefit. would recognize $5,000 of gain (which
[$75,000 × 20%]). The extra $17,000 of would represent 20% of the total gain
tax can come as an unwelcome surprise. Donating a PTP interest to a had the entire interest been sold) from
Depletion (like depreciation and charity or a private foundation the donation. This gain may be partially
amortization) is also a recapture item Can you get a tax benefit from donat- or fully offset by the suspended PALs.
that results in ordinary income and, ing a PTP interest? Many taxpayers are Additionally, when donating a PTP
because many PTPs are in the natural charitably inclined, and so when life gives interest to a charity, the charitable de-
resource industry, is a common issue for them lemons, they make lemonade by duction will be limited due to “hot asset”
sales of PTP interests. If the benefit of making a donation to charity. A donation ordinary income recapture items under
selling a PTP investment is simplifying of a PTP investment to a public charity Sec. 751, such as depreciation recapture
tax reporting, the recapture component may be an effective way to dispose of or depletion recapture. The charitable
is an additional loss on an already com- the investment with the added benefit deduction for the contribution of a PTP
plicated endeavor. of assisting a public charity; however, interest to a charity is the remainder of
additional tax implications should be the FMV for the units, less liabilities,
Gifting or transferring the PTP considered when donating PTP units. less ordinary income recapture, and less
interest When gifting a partnership interest any short-term capital gain. In effect,
Taxpayers sometimes think that they to a charity, the donor is deemed to have this could limit the deduction to basis in
will be able to realize the PALs by mak- proceeds equal to the amount of liabilities the units given.
ing a gift of the PTP interest. However, on the partnership interest gifted, result- Let us continue the example above
gifting the units will not allow the losses ing in a transaction that is part sale and and say that there is $15,000 of ordinary
to be recognized currently; instead, part gift (commonly referred to as a “bar- income recapture related to the PTP
PALs on gifted PTP units will be added gain sale”). Under Sec. 1011(b) and Regs. unit contribution. Because 20% of the
to the basis of the PTP interest in the Sec. 1.1011-2(b), the donor’s basis is allo- gain is recognized in the bargain sale,
donee’s hands under Sec. 469(j)(6). cated to the sale portion in proportion to 20% of the ordinary income recapture
Further, when gifting units encumbered the sale/gift amount, so in most cases, a would be recognized, so $3,000 ($15,000
by liabilities, a taxable event may occur. donation of partnership units will result ordinary income recapture × 20% (ratio

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