Question: Cooper is a general partner in a partnership. He has a 40% interest in the partnership, which he has held for more than one year. He decides to sell his entire interest in the partnership to an unrelated party and receives $40,000 from the sale. His outside basis in the partnership is $25,000. The partnership does not hold any hot assets; however, it does hold collectibles that have a basis of $7,000 and a fair market value of $12,000. Assuming that, in the year of sale, Cooper’s income will put him in the 15% long-term capital gains bracket, how much gain will he realize from the sale and what will be his tax liability related to the sale of his partnership interest?

Answer: Cooper will have a taxable long-term capital gain on the sale of his partnership interest of $15,000 ($40,000 sale proceeds less $25,000 basis in the partnership). Because the partnership holds collectibles, the portion of his gain related to his share of the collectibles must be taxed at 28%. To determine this amount, you will figure the gain from the deemed sale of collectibles, calculated as the difference between the fair market value on the date of the sale of the partnership interest and the partnership basis in the collectibles. In this case it is $5,000 ($12,000 - $7,000). Cooper’s allocable share of the gain from the collectibles, then, is $2,000 ($5,000 x 40% ownership in the partnership). This means that $2,000 of his gain will be taxed at 28%, resulting in $560 of tax.

The remaining portion of his $15,000 gain will be taxed at his normal long-term capital gains rate of 15%. Thus, his total tax related to the sale of his interest is $2,510 ($15,000 gain - $2,000 related to collectibles = $13,000 x 15% capital gains rate = $1,950 + $560 tax from sale of collectibles).