A summary of partner distributions and preference payments
A partnership distribution refers to the transfer of cash or property from a partnership to a partner related to their interest in partnership capital or income. Excluded from distributions are loans to partners, payments for services or property use (like rent), and guaranteed payments.
Distributions can be in the form of cash, property, or a reduction in a partner’s share of partnership liabilities. In a like-kind exchange involving encumbered property, a net reduction in debt due to the exchange is treated as boot, resulting in recognized gain. Gain from such exchanges spanning tax years is reported in the year the relinquished property is transferred.
Distinguishing between loans and distributions can be challenging. A transfer is considered a loan only if there’s an enforceable obligation to repay a specified amount by a certain date. A deficit in a partner’s capital account doesn’t constitute a loan, even if repayable under the partnership agreement. A canceled debt from a true loan is treated as a distribution, while a dispute over the loan’s existence results in treating it as a distribution when made.
Partnership agreements often include preferred distributions to provide a return on invested capital. These may take various forms affecting tax treatment, such as guaranteed payments or interest on loans depending on guarantees regarding capital return. Non-guaranteed preferred distributions are treated as current partnership distributions, potentially impacting income allocation under the partnership agreement.
At ShindelRock, we make sure that partners are very clear on how any preferred distribution requirements will interact with the allocation provisions of the partnership agreement. For more information, contact a ShindelRock tax professional today.