Section 731(c) generally treats marketable securities as money in determining gain or loss on a distribution to a partner. Section 731(a)(1) provides no gain is recognized on a distribution to a partner except to the extent any money distributed exceeds the adjusted basis of the partner in the partnership interest.

The term “marketable security” means financial instruments and foreign currencies that are, as of the date of the distribution, actively traded within the meaning of Section 1092(d)(1). For example, if a partnership distributes publicly traded stock with a value of $100 to a partner with an adjusted basis in her partnership interest of $50, the partner generally recognizes a gain of $50. However, there are a number of exceptions.

The first exception, in Section 731(c)(3)(A)(i), provides a marketable security is not treated as money if the partner receiving the security contributed the security to the partnership.

The second exception, in Section 731(c)(3)(A)(ii), provides a marketable security is not treated as money to the extent provided in regulations if the property was not a marketable security when acquired by the partnership. Reg. § 1.731-2(d)(iii) clarifies that is satisfied if (a) the entity that issued the security had no outstanding marketable securities when the security was acquired by the partnership; (b) the security was held by the partnership for at least six months before the security became marketable; and (c) the partnership distributed the security within five years of the security becoming marketable.

The third exception, in Section 731(c)(3)(A)(iii), provides a marketable security is not treated as money if the partnership is an investment partnership, and the partner is an eligible partner. A future blog post will describe what qualifies as an investment partnership and an eligible partner.

Finally, Section 731(c)(3)(B) provides for a reduction in the amount treated as money on a distribution of marketable securities equal to the difference between the partner’s distributive share of partnership net gain before the distribution and the partner’s distributive share of partnership net gain after the distribution. That is best demonstrated by Example 2 in Reg. § 1.731-2(j).

When gain is recognized as a result of Section 731(c), the basis of the marketable securities to which gain is recognized equals their basis as determined under Section 732 increased by the amount of such gain. IRC § 731(c)(4)(A).

John G. Hodnette, JD, LLM is an attorney with Culp, Elliott, & Carpenter in Charlotte.

January 12, 2022/by TAX