Income and Assets · Property, real and personal

Publicly traded partnerships

Two features make a publicly traded partnership behave unlike anything else an individual is likely to hold. Its passive losses are quarantined — they offset income from that partnership only, and stay suspended until the entire interest is disposed of. And on a sale, part of the gain is ordinary income under § 751 regardless of holding period, computed from a figure the partnership supplies rather than one the taxpayer can derive from the brokerage statement.

The rule

A publicly traded partnership is a corporation unless it escapes. For purposes of the title, and except as § 7704(c) provides, a publicly traded partnership is treated as a corporation (IRC § 7704(a)). The term means any partnership whose interests are traded on an established securities market, or are readily tradable on a secondary market or the substantial equivalent (§ 7704(b)(1), (2)).

The escape is a gross income test, applied cumulatively. Subsection (a) does not apply for a year if the partnership met the gross income requirements for that year and each preceding year beginning after 31 December 1987 during which it or a predecessor was in existence (IRC § 7704(c)(1)). It meets those requirements where 90 percent or more of gross income is qualifying income (§ 7704(c)(2)), a term defined by § 7704(d)(1) to include interest, dividends, real property rents, gain from real property, and income from mineral or natural resource activities. A partnership that would be a regulated investment company if it were a domestic corporation cannot use the exception (§ 7704(c)(3)).

The passive loss rules are applied one partnership at a time. Section 469 is applied separately with respect to items attributable to each publicly traded partnership, and § 469(i) — the rental real estate allowance — does not apply to those items at all (IRC § 469(k)(1)). A loss from one PTP therefore cannot offset income from another PTP, from any other passive activity, or from anything else.

And the suspended losses do not come free on a partial exit. For purposes of § 469(g), a taxpayer is not treated as having disposed of an entire interest in an activity of a publicly traded partnership until they dispose of the entire interest in the partnership (IRC § 469(k)(3)). Selling half the units releases nothing.

On a sale, the character starts as capital. Gain or loss on the sale or exchange of a partnership interest is recognised to the transferor and is gain or loss from the sale of a capital asset, except as otherwise provided in § 751 (IRC § 741).

Section 751 carves out an ordinary slice. The money or fair market value of property received in exchange for all or part of an interest, to the extent attributable to unrealized receivables or inventory items of the partnership, is treated as an amount realized from the sale of property other than a capital asset (IRC § 751(a)(1), (2)). That slice is ordinary income however long the units were held, and it can exceed the total gain, producing ordinary income and a capital loss on one transaction.

Outside basis moves every year. The adjusted basis of a partner’s interest is the contributed or purchased basis, increased by the distributive share of taxable income, of tax-exempt income, and of excess depletion deductions, and decreased — but not below zero — by distributions and by the distributive share of losses and of nondeductible, non-capital expenditures (IRC § 705(a)(1), (2)). For a PTP holder this is the number the brokerage statement does not have: cash distributions have been reducing basis year after year, so the gain on sale is usually far larger than the difference between the sale proceeds and what was paid.

A transferee may have to withhold. Where any portion of the gain on a disposition of a partnership interest would be effectively connected income under § 864(c)(8), the transferee must deduct and withhold 10 percent of the amount realized (IRC § 1446(f)(1)) — unless the transferor furnishes an affidavit under penalty of perjury giving their taxpayer identification number and stating that they are not a foreign person (§ 1446(f)(2)(A)).

Current figures

How it works in practice

The annual return work is mostly bookkeeping and it has to be kept per partnership. Each PTP’s Schedule K-1 feeds its own column: income offsets that partnership’s suspended losses first, and any remaining loss joins the suspended pile for that partnership alone. A spreadsheet with one row per PTP per year is not optional — nothing on the return itself carries the tracking forward, and a client who has held six partnerships for a decade has six independent histories.

On disposal, three numbers matter and only one of them is on the broker’s statement. The proceeds come from the broker. The adjusted basis comes from the § 705 running account, which the partnership usually supplies as a sales schedule with the final K-1. The ordinary income portion comes from that same schedule, because § 751 requires the partnership’s own inside figures for unrealized receivables and inventory. Reporting a PTP sale from the Form 1099-B alone will overstate basis and miss the ordinary component entirely.

Expect the arithmetic to be counterintuitive. Years of cash distributions reduce basis without being taxed, so a unit bought for 30 dollars and sold for 25 can produce a gain. And the § 751 amount is computed independently of the overall result, so a taxpayer with an economic loss can still report ordinary income, offset by a capital loss constrained by the annual capital loss allowance.

How this has changed

Section 7704 was enacted to stop the growth of publicly traded partnerships and left a defined survivor class. The corporate default in subsection (a) is the rule; the § 7704(c) exception is what lets today’s energy and pipeline partnerships remain partnerships. Note how demanding the exception is: § 7704(c)(1) requires the 90 percent test to have been met not only for the year in question but for every preceding year after 1987 in which the partnership existed. A single failed year is not a one-year problem.

Section 1446(f) added a withholding obligation that reaches ordinary secondary-market sales. Where any part of the gain would be effectively connected income, a transferee must withhold 10 percent of the amount realized unless a non-foreign affidavit is furnished. For publicly traded interests the mechanics run through brokers rather than the buyer personally, but the statutory obligation is on the transferee, and material predating this provision describes a sale with no withholding dimension at all.

Section 199A brought PTP income into the qualified business income computation as a separate component, which changed how the K-1 has to be read but not the rules on this page. The interaction is worth flagging because it gives PTP income a second, unrelated silo alongside the § 469(k) one.

What has not changed is the § 751 mechanism, and it remains the most reliable source of error. The provision has read the same way for decades, and the difficulty is entirely practical: the taxpayer cannot compute the ordinary portion, the partnership must supply it, and the supply arrives with the final Schedule K-1 rather than with the trade confirmation.

Exam focus

Expect the quarantine to be tested with two partnerships in the facts, one profitable and one not. The loss does not offset the income.

Expect a partial disposition with suspended losses, testing § 469(k)(3). Nothing is released.

Expect a sale computation where the proceeds are below the original cost and the answer is a gain, because distributions reduced basis under § 705(a)(2).

Expect § 751 as a character question: the ordinary portion is ordinary regardless of holding period, and it can leave a capital loss on the same transaction.

Check yourself

1. A taxpayer has a 5,000-dollar loss from PTP A and 5,000 dollars of income from PTP B. What is reported?

Answer: 5,000 dollars of income from PTP B, with PTP A’s loss suspended. IRC § 469(k)(1) applies § 469 separately to the items of each publicly traded partnership, so the two do not net.

2. Units bought for 20,000 dollars, cumulative income allocations of 3,000 dollars, cumulative cash distributions of 9,000 dollars. What is the adjusted basis?

Answer: 14,000 dollars — 20,000 increased by the 3,000-dollar distributive share of income under IRC § 705(a)(1)(A) and decreased by the 9,000 dollars of distributions under § 705(a)(2).

3. The same units are sold for 17,000 dollars, and the sales schedule shows 6,000 dollars of § 751 ordinary income. What is reported?

Answer: A total gain of 3,000 dollars, of which 6,000 dollars is ordinary income under IRC § 751(a), leaving a 3,000-dollar capital loss. Both are reported; the ordinary portion is not reduced by the capital result.

4. A taxpayer sells 60 percent of their units in a PTP with suspended losses. Are the losses released?

Answer: No. IRC § 469(k)(3) provides that the taxpayer is not treated as having disposed of the entire interest in an activity until the entire interest in the partnership is disposed of.

5. Why is a publicly traded partnership not taxed as a corporation?

Answer: Because IRC § 7704(c) disapplies the § 7704(a) default where 90 percent or more of gross income is qualifying income under § 7704(d), tested for the year and for every preceding year after 1987 in which the partnership existed.