Partnership Dissolved - Passive Activity Loss Adjustment

[Yardley CPA]

Client, Husband and Wife, MFJ...were in a partnership with a third party.  They owned a rental home together since 2011.  Shared income and expenses 50% / 50%.  The relationship went sour and my clients sold their share to the third party for $1 on 3/31/2018 and are no longer involved in the partnership or with this third party.  The partnership will be formally dissolved. 

I've never dealt with this type of situation and would appreciate any comments, suggestions on how to handle this.  

Here's what the 4797 looks like:

This note is located on the top of the 4797:

I assume I go to the Schedule E Activity Page and place check Line 4 with an X?

 Is this correct?  

[DANRVAN]

Looks like you might have some gifting going on.

 

[Lion EA]

Were your clients relieved of any mortgage or other debt? Did they sell their share of a rental home? Or did they sell their partnership interests? What do their Form K-1 look like? You're preparing their joint 1040, right? Or, the 1065? Or, both? Yeah, gifting...

[DANRVAN]

39 minutes ago, Lion EA said:

Were your clients relieved of any mortgage or other debt? Did they sell their share of a rental home? Or did they sell their partnership interests? What do their Form K-1 look like? You're preparing their joint 1040, right? Or, the 1065? Or, both? Yeah, gifting...

Best tax treatment might be abandonment of property or of partnership interest depending on facts and circumstances.  Unfortunately they did not get tax advice before they signed the $1 deal,  although that is not the final determining factor.  

That $1 might have been the most they could get out of the deal so maybe no gifting here.  As Lion pointed out, was there any relief of liabilities?

[Yardley CPA]

I am preparing the clients 1040 along with the 1065 for the Partnership.  All income and expenses were handled on the individuals Schedule E.  Nothing really flowed through the partnership.  Not sure if that is correct, but that is how it was setup originally prior to my involvement.  K-1's had little to no activity reported on them. 

My clients were paying half of the mortgage.  The other party became unresponsive to communicating.  Other party would rarely engage my clients.  So the relationship went south and in order to relieve themselves of any obligation (or continued stress) they agreed to sell their share for $1 and be done with that "investment". 

[DANRVAN]

Not abandoned since they transferred title.

How much debt was relieved?

Would probably report on 4797 with debt relieved as consideration.

[Yardley CPA]

I very much appreciate all the advice.  I will look into how much debt was relieved.  

[Yardley CPA]

Clients were relieved of their portion of the mortgage which amounted to  $75,910.  Where would this figure be entered on the 4797?  

[jklcpa]

Relief from a partnership liability is considered a deemed distribution and treated the same as cash received in liquidation would be. 

[DANRVAN]

2 hours ago, jklcpa said:

Relief from a partnership liability is considered a deemed distribution and treated the same as cash received in liquidation would be. 

In this case it sounds like the property and mortgage were held by the individuals instead of the partnership.

Otherwise I agree, it would then be treated as a 736(b) payment.

[DANRVAN]

25 minutes ago, DANRVAN said:

 

Otherwise I agree, it would then be treated as a 736(b) payment.

On second thought, it would be treated as a sale of partnership interest and termination of the partnership.

[Yardley CPA]

16 hours ago, jklcpa said:

Relief from a partnership liability is considered a deemed distribution and treated the same as cash received in liquidation would be. 

So would the amount of the mortgage relieved be added to the sales price on the 4797?

Thank you again for all the feedback.

[DANRVAN]

On 3/3/2019 at 5:43 AM, Yardley CPA said:

So would the amount of the mortgage relieved be added to the sales price on the 4797?

Thank you again for all the feedback.

Yes.