[Code of Federal Regulations]
[Title 26, Volume 8]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.731-1]

[Page 501-502]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Determination of Tax Liability--Table of Contents
 
Sec. 1.731-1  Extent of recognition of gain or loss on distribution.

    (a) Recognition of gain or loss to partner--(1) Recognition of gain. 
(i) Where money is distributed by a partnership to a partner, no gain 
shall be recognized to the partner except to the extent that the amount 
of money distributed exceeds the adjusted basis of the partner's 
interest in the partnership immediately before the distribution. This 
rule is applicable both to current distributions (i.e., distributions 
other than in liquidation of an entire interest) and to distributions in 
liquidation of a partner's entire interest in a partnership. Thus, if a 
partner with a basis for his interest of $10,000 receives a distribution 
of cash of $8,000 and property with a fair market value of $3,000, no 
gain is recognized to him. If $11,000 cash were distributed, gain would 
be recognized to the extent of $1,000. No gain shall be recognized to a 
distributee partner with respect to a distribution of property (other 
than money) until he sells or otherwise disposes of such property, 
except to the extent otherwise provided by section 736 (relating to 
payments to a retiring partner or a deceased partner's successor in 
interest) and section 751 (relating to unrealized receivables and 
inventory items). See section 731(c) and paragraph (c) of this section.
    (ii) For the purposes of sections 731 and 705, advances or drawings 
of money or property against a partner's distributive share of income 
shall be treated as current distributions made on the last day of the 
partnership taxable year with respect to such partner.
    (2) Recognition of loss. Loss is recognized to a partner only upon 
liquidation of his entire interest in the partnership, and only if the 
property distributed to him consists solely of money, unrealized 
receivables (as defined in section 751(c)), and inventory items (as 
defined in section 751(d)(2)). The term liquidation of a partner's 
interest, as defined in section 761(d), is the termination of the 
partner's entire interest in the partnership by means of a distribution 
or a series of distributions. Loss is recognized to the distributee 
partner in such cases to the extent of the excess of the adjusted basis 
of such partner's interest in the partnership at the time of the 
distribution over the sum of:
    (i) Any money distributed to him, and
    (ii) The basis to the distributee, as determined under section 732, 
of any unrealized receivables and inventory items that are distributed 
to him.

If the partner whose interest is liquidated receives any property other 
than money, unrealized receivables, or inventory items, then no loss 
will be recognized. Application of the provisions of this subparagraph 
may be illustrated by the following examples:

    Example 1. Partner A has a partnership interest in partnership ABC 
with an adjusted basis to him of $10,000. He retires from the 
partnership and receives, as a distribution in liquidation of his entire 
interest, his share of partnership property. This share is $5,000 cash 
and inventory with a basis to him (under section 732) of $3,000. Partner 
A realizes a capital loss of $2,000, which is recognized under section 
731(a)(2).
    Example 2. Partner B has a partnership interest in partnership BCD 
with an adjusted basis to him of $10,000. He retires from the

[[Page 502]]

partnership and receives, as a distribution in liquidation of his entire 
interest, his share of partnership property. This share is $4,000 cash, 
real property (used in the trade or business) with an adjusted basis to 
the partnership of $2,000, and unrealized receivables having a basis to 
him (under section 732) of $3,000. No loss will be recognized to B on 
the transaction because he received property other than money, 
unrealized receivables, and inventory items. As determined under section 
732, the basis to B for the real property received is $3,000.

    (3) Character of gain or loss. Gain or loss recognized under section 
731(a) on a distribution is considered gain or loss from the sale or 
exchange of the partnership interest of the distributee partner, that 
is, capital gain or loss.
    (b) Gain or loss recognized by partnership. A distribution of 
property (including money) by a partnership to a partner does not result 
in recognized gain or loss to the partnership under section 731. 
However, recognized gain or loss may result to the partnership from 
certain distributions which, under section 751(b), must be treated as a 
sale or exchange of property between the distributee partner and the 
partnership.
    (c) Exceptions. (1) Section 731 does not apply to the extent 
otherwise provided by:
    (i) Section 736 (relating to payments to a retiring partner or to a 
deceased partner's successor in interest) and
    (ii) Section 751 (relating to unrealized receivables and inventory 
items).

For example, payments under section 736(a), which are considered as a 
distributive share or guaranteed payment, are taxable as such under that 
section.
    (2) The receipt by a partner from the partnership of money or 
property under an obligation to repay the amount of such money or to 
return such property does not constitute a distribution subject to 
section 731 but is a loan governed by section 707(a). To the extent that 
such an obligation is canceled, the obligor partner will be considered 
to have received a distribution of money or property at the time of 
cancellation.
    (3) If there is a contribution of property to a partnership and 
within a short period:
    (i) Before or after such contribution other property is distributed 
to the contributing partner and the contributed property is retained by 
the partnership, or
    (ii) After such contribution the contributed property is distributed 
to another partner,

such distribution may not fall within the scope of section 731. Section 
731 does not apply to a distribution of property, if, in fact, the 
distribution was made in order to effect an exchange of property between 
two or more of the partners or between the partnership and a partner. 
Such a transaction shall be treated as an exchange of property.