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A previous post addressed the two basic deal structures—asset purchases and stock purchases—and their respective tax consequences in the context of a corporate acquisition. This post will discuss the general tax implications of either deal structure when the transacting parties are partnerships.
In an asset purchase from a partnership, the tax consequences to the buyer are the same as for an asset purchase from a corporation. In such an asset sale, the partnership is selling the various assets of the partnership separately and the aggregate purchase price is allocated among each asset acquired. The buyer takes ownership of the transferred assets using bases stepped up to the purchase price paid, as allocated. Gains or losses on the transfers are passed through to the partners, who directly recognize their share of the partnership’s gain or loss on the asset. This contrasts with an asset sale and liquidation by a corporation, which gives rise to taxation recognized by the seller at both the corporate and shareholder level.
Consequently, to the seller, the difference in the tax consequences between a transfer of partnership interests and a transfer of assets is much less significant than the difference between a stock deal or asset deal with a corporation. As with a stock sale, the transfer of a partnership interest typically causes a capital gain or loss equal to the difference between the original partner’s adjusted basis in the interest and the fair market value paid. The price paid is based on the fair market value of the partnership interest, which is in turn based on the value of the partnership’s assets. However, when those assets include ordinary income assets, also known as hot assets, the seller will incur an immediate tax liability based on its percentage interest in the value of the hot assets.
One the buyer’s side, there are two branches of tax consequences. First, the incoming partner’s basis in the acquired partnership interest, known as the outside basis, is stepped up to equal the amount paid. The buyer also takes an undivided interest in its share of the bases of the partnership’s assets—the inside basis. Any gain or loss from a sale by the partnership of its assets passes to the incoming partner based on the partner’s inside basis, along with the availability of depreciation deductions and amortization. Incoming partners should be aware that their expected economics may suffer adversely if a mismatch exists between their inside and outside basis.
Such a mismatch will occur when the partnership has substantially appreciated, depreciated, or amortized assets for tax purposes. If the partnership makes a Section 754 election, the incoming partner takes a step up or step down for any difference between the amount paid and the proportionate value of the assets of the partnership. Section 754 elections are generally permanent so the partnership needs to determine whether any short terms benefits from the election will be outweighed by the long term effects.