CPA Regulation Reg Quiz: Apply Partnership Distributions And Liquidations

What this quiz covers

This quiz focuses on Apply Partnership Distributions And Liquidations, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA Regulation Reg.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

Question 1

1. $0, because current distributions never trigger gain recognition.
2. $15,000, the excess of cash received over the partner's outside basis. (correct answer)
3. $40,000, the full amount of cash distributed.
4. $25,000, the partner's outside basis before the distribution.

Explanation: Under Section 731(a)(1), a partner recognizes gain on a current distribution only to the extent that money distributed exceeds the partner's outside basis immediately before the distribution. Cash of $40,000 minus outside basis of$25,000 = $15,000 gain. This gain is typically capital gain. Answer A is incorrect because cash distributions exceeding outside basis do trigger gain. Answer C ($40,000) ignores the basis offset. Answer D ($25,000) is the outside basis itself, not the recognized gain.

Question 2

1. When the liquidating distribution consists solely of cash, unrealized receivables, and inventory, and the cash and the basis of the unrealized receivables and inventory is less than the partner's outside basis. (correct answer)
2. When the fair market value of property distributed in liquidation is less than the partner's outside basis.
3. When the partner's share of partnership liabilities decreases as part of the liquidation.
4. When the partnership distributes appreciated property and the partner has a low outside basis.

Explanation: Under Section 731(a)(2), a partner may recognize a loss on a liquidating distribution only if the distribution consists solely of money, unrealized receivables, and inventory items, and the sum of money received plus the basis of unrealized receivables and inventory is less than the partner's outside basis. No loss is recognized if the liquidating distribution includes any other property. Answer B is incorrect because loss is not recognized simply because FMV is below outside basis; the distribution must meet the all-cash/receivables/inventory test. Answer C is incorrect because a decrease in partnership liabilities is treated as a deemed cash distribution, which can trigger gain but the scenario described does not automatically produce a recognizable loss in the way Section 731(a)(2) requires. Answer D is incorrect because distribution of appreciated property does not trigger a loss for the distributee partner.

Question 3

1. The basis equals the fair market value of each asset received, allocated proportionally.
2. The basis equals the partnership's adjusted basis in each asset distributed.
3. The basis equals zero for all assets received in a liquidating distribution.
4. The basis equals the partner's outside basis reduced by any cash received, with the remainder allocated among the distributed assets. (correct answer)

Explanation: Under Section 732(b), in a complete liquidating distribution, the partner's total basis in all distributed property equals the partner's outside basis reduced by any cash received in the same distribution. This remaining basis is then allocated among the non-cash assets under the Section 732(c) ordering rules: first to unrealized receivables and inventory (up to their partnership basis), then to any remaining assets. Answer A (FMV basis) would apply only if gain were fully recognized. Answer B (partnership's adjusted basis) is the rule for current distributions under Section 732(a), subject to the outside basis cap, not the liquidating distribution rule. Answer C ($0 basis) has no basis in the Code.

Question 4

1. $15,000
2. $30,000 (correct answer)
3. $35,000
4. $50,000

Explanation: Under Section 732(b), the partner's basis in property received in a liquidating distribution = outside basis minus cash received = $50,000 -$20,000 = $30,000. This$30,000 is allocated to the equipment. The partnership's basis in the equipment ($15,000) does not cap the liquidating distribution basis since Section 732(b) (not 732(a)) applies. The partner takes a$30,000 basis in the equipment, absorbing the full remaining outside basis. Answer A ($15,000) is the partnership's basis, which serves as a cap in current (not liquidating) distributions. Answer C ($35,000) incorrectly adds cash to the remaining basis. Answer D ($50,000) ignores the cash received.

Question 5

1. Marketable securities are treated the same as other non-cash property and never trigger gain recognition in a current distribution.
2. Marketable securities are treated as cash but only to the extent they were acquired by the partnership within the last 12 months.
3. Marketable securities are excluded from the partnership distribution rules and always taxed at ordinary income rates.
4. Marketable securities are treated as money (cash) for purposes of the distribution rules, so a distribution of securities can trigger gain if their FMV exceeds the partner's outside basis. (correct answer)

Explanation: Under Section 731(c), marketable securities distributed by a partnership are generally treated as money (cash) equal to their fair market value for purposes of the Section 731 gain recognition rule. This means if the FMV of the securities exceeds the partner's outside basis, gain is recognized just as if cash had been distributed. This rule prevents partners from using partnerships to distribute appreciated publicly traded securities tax-free. Answer A is incorrect because Section 731(c) specifically treats marketable securities as cash, which can trigger gain. Answer B is incorrect because the 12-month acquisition rule is not the primary standard; Section 731(c) applies broadly to marketable securities. Answer C is incorrect because the securities are treated as money, not as ordinary income assets per se.

Question 6

1. All assets receive basis equal to their fair market value, regardless of the partner's outside basis.
2. Basis is first allocated to unrealized receivables and inventory up to their partnership basis; any remaining basis is allocated to other assets using a fair-market-value proportional method with specific adjustments. (correct answer)
3. All assets share the outside basis equally, divided by the number of assets received.
4. Basis is allocated first to capital assets, then to Section 1231 assets, and finally to inventory.

Explanation: Section 732(c) establishes a two-tier ordering rule for allocating basis in liquidating distributions. First, basis is allocated to unrealized receivables and inventory items in an amount equal to the partnership's adjusted basis in those assets (but not to exceed the total basis being allocated). Second, any remaining basis is allocated to other distributed properties. If the remaining basis exceeds the total adjusted basis of the other assets, the excess is allocated proportionally based on fair market values (positive adjustments). If basis is insufficient, reductions are made based on depreciation potential and then FMV. Answer A (FMV basis for all) ignores the statutory ordering. Answer C (equal split) has no basis in Section 732(c). Answer D reverses the correct priority.

Question 7

1. Basis in land = $45,000; remaining outside basis =$0.
2. Basis in land = $30,000; remaining outside basis =$0.
3. Basis in land = $20,000; remaining outside basis =$10,000. (correct answer)
4. Basis in land = $20,000; remaining outside basis =$0.

Explanation: Under Section 732(a)(1), in a current distribution of property other than cash, the partner's basis in the distributed property equals the lesser of the partnership's adjusted basis in the property or the partner's outside basis. The partnership's basis in the land = $20,000; partner's outside basis =$30,000. Lesser = $20,000. Leo takes a$20,000 basis in the land. His remaining outside basis = $30,000 -$20,000 = $10,000. Answer A uses FMV as basis. Answer B uses the full outside basis. Answer D correctly states$20,000 basis in the land but incorrectly reduces remaining outside basis to $0.

Question 8

1. Nadia recognizes $20,000 of ordinary income because the distribution exceeds her outside basis.
2. Nadia recognizes $20,000 of capital gain because the cash received in a liquidating distribution exceeding outside basis is capital gain. (correct answer)
3. Nadia recognizes no gain because liquidating distributions are always tax-free.
4. Nadia recognizes $120,000 of capital gain equal to the full liquidating distribution.

Explanation: Under Section 731(a)(1), a partner recognizes gain in a liquidating (or current) distribution to the extent money distributed exceeds the partner's outside basis. Gain = $120,000 -$100,000 = $20,000. Under Section 741, gain on the liquidation of a partnership interest is generally treated as capital gain (subject to Section 751 recharacterization for hot assets, which are not present here). Answer A is incorrect because the gain is capital, not ordinary, in the absence of hot assets. Answer C is incorrect because distributions of cash exceeding outside basis do trigger gain recognition. Answer D ($120,000) ignores the outside basis offset.

Question 9

1. The partner must recognize gain equal to the lesser of the pre-contribution gain in the contributed property or the excess of the FMV of property received over the partner's outside basis, if the distribution occurs within 7 years of the contribution. (correct answer)
2. The partner recognizes gain equal to the full FMV of the distributed property in all cases.
3. The partner recognizes gain only if the contributed property has been sold by the partnership before the distribution.
4. The partner recognizes no gain because the partner is merely receiving a return of investment.

Explanation: Section 737 is the anti-mixing bowl rule that prevents a contributing partner from extracting other property from the partnership tax-free when contributed property with built-in gain remains in the partnership. If, within 7 years of a contribution, the contributing partner receives a distribution of other property with an FMV exceeding the partner's outside basis, gain is recognized equal to the lesser of (1) the net pre-contribution gain in the contributed property still held by the partnership, or (2) the excess of the FMV of distributed property over the partner's outside basis. Answer B is incorrect because gain is limited to the lesser of pre-contribution gain or the FMV-over-basis excess. Answer C is incorrect because Section 737 triggers even if the contributed property has not been sold; the sale triggers Section 704(c)(1)(B) instead. Answer D is incorrect because Section 737 specifically overrides the general nonrecognition rule in these circumstances.

Question 10

1. Partner Z has no obligation because general partners are not required to restore negative capital account balances.
2. Partner Z must recognize the $30,000 as capital gain income in the year of liquidation.
3. Partner Z must contribute $30,000 to the partnership to restore the negative capital account balance before the final distribution. (correct answer)
4. The $30,000 is forgiven as a discharge of indebtedness income to Partner Z.

Explanation: When a partnership agreement includes a deficit restoration obligation (DRO), a partner with a negative capital account must contribute the deficit amount to the partnership before final distributions are made. Partner Z must contribute $30,000 to restore the capital account to zero; those funds may then be distributed to partners with positive capital account balances. Answer C is correct. Answer A is incorrect because the partnership agreement here expressly requires deficit restoration - absent such an obligation, the analysis would differ. Answer B is incorrect because a negative capital account creates a contribution obligation, not capital gain income. Answer D is incorrect because this situation involves a capital account deficit governed by the partnership agreement, not a discharge of indebtedness under Section 108.

Question 11

1. $0, because the distribution exceeds half the partnership's value.
2. $50,000, equal to the cash distributed.
3. $30,000, reduced by the cash distributed. (correct answer)
4. $80,000, unchanged because current distributions do not affect outside basis.

Explanation: Under Section 733, a partner's outside basis is reduced (but not below zero) by the amount of money distributed in a current distribution. Each partner's outside basis = $80,000 -$50,000 = $30,000. No gain is recognized because the cash distributed ($50,000) does not exceed the outside basis ($80,000). Answer A is incorrect because the distribution does not reduce basis below zero, and no gain is recognized here. Answer B is incorrect; the remaining outside basis is$30,000, not $50,000. Answer D is incorrect because cash distributions do reduce outside basis under Section 733.

Question 12

1. First to partners in proportion to their capital contributions, then to creditors, then to partners for their profit shares.
2. First to limited partners equally, then to the general partner, then to creditors.
3. First to partners for past unpaid distributions, then equally to all partners, then to creditors.
4. First to creditors, then to partners in accordance with their positive capital account balances or as provided in the partnership agreement. (correct answer)

Explanation: Upon winding up a limited partnership, distributions are made in the following priority: (1) to creditors (including partner-creditors) for debts and liabilities, and (2) to partners in accordance with their positive capital account balances or as the partnership agreement provides. This creditor-first priority reflects basic principles of entity law and partnership statutes. Answer A reverses the priority by paying partners before creditors. Answer B is incorrect because the order is not based on partner type (limited vs. general) but on the claims hierarchy of creditors first, then equity. Answer C is incorrect in suggesting unpaid distributions take priority over creditor claims.

Question 13

1. $0, because the partner's outside basis is$0 and Section 732(a) limits the basis to the lesser of partnership basis or outside basis. (correct answer)
2. $25,000, the partnership's adjusted basis in the property.
3. $40,000, the fair market value of the distributed property.
4. $15,000, the difference between FMV and partnership basis.

Explanation: Under Section 732(a)(2), the partner's basis in distributed property in a current distribution cannot exceed the partner's outside basis reduced by any cash received in the same distribution. Since the partner's outside basis is $0 and no cash was distributed, the basis in the property is$0. No gain is recognized in a current distribution of property (only cash distributions exceeding outside basis trigger gain). The zero basis means that when the partner later sells the property, the full proceeds will be taxable. Answer B ($25,000) would apply if outside basis were at least$25,000. Answer C (FMV) would apply if gain were recognized. Answer D ($15,000) has no basis in Section 732.

Question 14

1. The distribution is completely tax-free because no cash changes hands.
2. The distribution triggers capital gain to the extent of the disproportionate shift in partnership assets.
3. The distribution is treated as a sale of partnership interest and fully taxed at ordinary rates.
4. The distribution is treated as a deemed sale and purchase of assets between the partner and the partnership, triggering ordinary income to the extent hot assets are involved. (correct answer)

Explanation: Section 751(b) applies when a partnership distribution is disproportionate with respect to hot assets (unrealized receivables and substantially appreciated inventory). The disproportionate distribution is treated as if the partner sold the hot assets they gave up in exchange for the other assets they received (or vice versa). This deemed sale triggers ordinary income to the extent the transaction involves hot assets. Answer A is incorrect because Section 751(b) specifically overrides the general nonrecognition rules for disproportionate distributions. Answer B is incorrect because the character of income triggered by hot assets under Section 751 is ordinary, not capital. Answer C overstates the scope; only the hot asset component is recharacterized as ordinary, not the entire distribution.

Question 15

1. $25,000 (correct answer)
2. $20,000
3. $35,000
4. $65,000

Explanation: Under Section 732(b), in a liquidating distribution the partner's total basis in distributed non-cash property = outside basis minus cash received = $65,000 -$40,000 = $25,000. This$25,000 is allocated to the capital asset. Note that the capital asset has a partnership basis of $20,000, but in a liquidating distribution the Section 732(b) allocated basis ($25,000) is used rather than being capped at partnership basis. Answer B ($20,000) is the partnership's basis in the asset, which would apply in a current distribution under Section 732(a). Answer C ($35,000) is the FMV of the asset. Answer D ($65,000) is the partner's full outside basis before the cash distribution.

Question 16

1. $50,000
2. $70,000 (correct answer)
3. $90,000
4. $20,000

Explanation: In a liquidating distribution under Section 732(b), the partner's basis in distributed property equals the partner's outside basis reduced by any cash received. No cash was received by Partner X. Therefore, Partner X's basis in the land = $70,000 (the full outside basis). This basis exceeds the partnership's$50,000 basis in the land, which means Partner X has a step-up embedded in the property (which may be adjusted via Section 734(b) if a Section 754 election is in effect). Answer A ($50,000) is the partnership's basis, applicable in current distributions under Section 732(a), not liquidating distributions. Answer C ($90,000) is the FMV. Answer D ($20,000) is the excess of outside basis over partnership property basis.

Question 17

1. Payments for the partner's share of unrealized receivables and goodwill (unless the partnership agreement provides for goodwill), which are treated as distributive shares or guaranteed payments.
2. Payments that are always deductible by the remaining partners.
3. Payments for the partner's share of partnership property (other than unrealized receivables and goodwill not provided for in the partnership agreement), which are treated as liquidating distributions. (correct answer)
4. Payments made over time under an installment arrangement that are taxed entirely as capital gains.

Explanation: Section 736(b) payments are payments for the retiring or deceased partner's interest in partnership property (other than unrealized receivables and, in general service partnerships, goodwill not specifically provided for in the partnership agreement). These payments are treated as liquidating distributions under Section 731 and Section 732, resulting in capital gain or loss to the recipient. Answer A describes Section 736(a) payments, which cover the residual - payments for unrealized receivables and unstated goodwill - and are treated as distributive shares of income or guaranteed payments. Answer B is incorrect because Section 736(b) payments are not deductible by the partnership; Section 736(a) payments may be deductible. Answer D is incorrect because installment treatment does not change the character classification under Section 736.

Question 18

1. Long-term capital gain of $10,000.
2. Section 1231 gain of $10,000.
3. Ordinary income of $2,000.
4. Ordinary income of $10,000. (correct answer)

Explanation: Quinn's basis in the distributed inventory = lesser of partnership basis ($12,000) or outside basis ($18,000) = $12,000 under Section 732(a). Under Section 735(a)(2), inventory distributed by a partnership retains its ordinary income character for 5 years after distribution, regardless of the distributee's holding period. Quinn sells for$22,000, basis = $12,000, gain =$10,000. Because this is inventory and the 5-year rule applies (assuming sale is within 5 years), the entire $10,000 gain is ordinary income. Answer A is incorrect because inventory triggers ordinary income, not capital gain. Answer B is incorrect because Section 1231 treatment does not apply to inventory. Answer C ($2,000) would be the gain only if basis were $20,000 (FMV), which is incorrect.

Question 19

1. The Section 754 election eliminates the partner's gain on any future sale of the distributed property.
2. The Section 754 election converts the character of the partner's gain from ordinary to capital.
3. The Section 754 election allows the partnership to adjust the basis of its remaining assets under Section 734(b) to reflect the difference caused by the distribution. (correct answer)
4. The Section 754 election allows the distributing partnership to recognize gain on the distributed property at the time of distribution.

Explanation: A Section 754 election, when in effect, triggers two types of optional basis adjustments: Section 743(b) adjustments on transfers of partnership interests, and Section 734(b) adjustments on distributions of property. When a distribution causes a basis disparity (such as when a partner takes a higher or lower basis in distributed property than the partnership's inside basis), Section 734(b) allows the partnership to adjust the basis of its remaining assets to eliminate the inside/outside basis imbalance. This prevents other partners from being harmed or benefited by the disparity. Answer A is incorrect because the election adjusts the partnership's inside basis in remaining assets, not the distributee's basis. Answer B is incorrect because the Section 754 election does not affect the character of gain. Answer D is incorrect because the distributing partnership does not recognize gain on a distribution subject to Section 734(b).

Question 20

1. Unrealized receivables and inventory items (including substantially appreciated inventory). (correct answer)
2. Depreciable equipment and real property held for more than one year.
3. Cash and marketable securities held by the partnership.
4. Capital assets and Section 1231 assets held by the partnership.

Explanation: Section 751 hot assets include unrealized receivables and inventory items. Unrealized receivables include rights to payment for goods delivered or services rendered, as well as recapture amounts under Sections 1245 and 1250. Inventory items include not only stock-in-trade but also any property that would not be a capital asset or Section 1231 asset if held directly. On a sale or exchange of a partnership interest, gain or loss attributable to hot assets is treated as ordinary income or loss. Answer B (depreciable equipment and real property) describes Section 1231 assets, not hot assets. Answer C (cash and marketable securities) are generally capital assets, not hot assets. Answer D (capital and Section 1231 assets) describes non-hot assets that receive capital gain treatment.