§ 1.731-2. Partnership distributions of marketable securities.

(i) A and B form partnership AB as equal partners. A contributes property with a fair market value of $1,000 and an adjusted tax basis of $250. B contributes $1,000 cash. AB subsequently purchases Security X for $500 and immediately distributes the security to A in a current distribution. The basis in A's interest in the partnership at the time of distribution is $250.

(ii) The distribution of Security X is treated as a distribution of money in an amount equal to the fair market value of Security X on the date of distribution ($500). (The amount of the distribution that is treated as money is not reduced under section 731(c)(3)(B) and paragraph (b) of this section because, if Security X had been sold immediately before the distribution, there would have been no gain recognized by AB and A's distributive share of the gain would therefore have been zero.) As a result, A recognizes $250 of gain under section 731(a)(1) on the distribution ($500 distribution of money less $250 adjusted tax basis in A's partnership interest).

(i) A and B form partnership AB as equal partners. AB subsequently distributes Security X to A in a current distribution. Immediately before the distribution, AB held securities with the following fair market values, adjusted tax bases, and unrecognized gain or loss:

(ii) If AB had sold the securities for fair market value immediately before the distribution to A, the partnership would have recognized $40 of net gain ($30 gain on Security X plus $20 gain on Security Y minus $10 loss on Security Z). A's distributive share of this gain would have been $20 (one-half of $40 net gain). If AB had sold the remaining securities immediately after the distribution of Security X to A, the partnership would have $10 of net gain ($20 of gain on Security Y minus $10 loss on Security Z). A's distributive share of this gain would have been $5 (one-half of $10 net gain). As a result, the distribution resulted in a decrease of $15 in A's distributive share of the net gain in AB's securities ($20 net gain before distribution minus $5 net gain after distribution).

(iii) Under paragraph (b) of this section, the amount of the distribution of Security X that is treated as a distribution of money is reduced by $15. The distribution of Security X is therefore treated as a distribution of $85 of money to A ($100 fair market value of Security X minus $15 reduction).

(i) A and B form partnership AB. A contributes $1,000 and provides substantial services to the partnership in exchange for a 60 percent interest in partnership profits. B contributes $1,000 in exchange for a 40 percent interest in partnership profits. AB subsequently distributes Security X to A in a current distribution. Immediately before the distribution, AB held securities with the following fair market values, adjusted tax bases, and unrecognized gain:

(ii) If AB had sold the securities for fair market value immediately before the distribution to A, the partnership would have recognized $30 of net gain ($20 gain on Security X plus $10 gain on Security Y). A's distributive share of this gain would have been $18 (60 percent of $30 net gain). If AB had sold the remaining securities immediately after the distribution of Security X to A, the partnership would have $10 of net gain ($10 gain on Security Y). A's distributive share of this gain would have been $6 (60 percent of $10 net gain). As a result, the distribution resulted in a decrease of $12 in A's distributive share of the net gain in AB's securities ($18 net gain before distribution minus $6 net gain after distribution).

(iii) Under paragraph (b) of this section, the amount of the distribution of Security X that is treated as a distribution of money is reduced by $12. The distribution of Security X is therefore treated as a distribution of $88 of money to A ($100 fair market value of Security X minus $12 reduction).

(i) A is admitted to partnership ABC as a partner with a 1 percent interest in partnership profits. At the time of A's admission, ABC held no securities. ABC subsequently acquires Security X. A's interest in partnership profits is subsequently increased to 2 percent for securities acquired after the increase. A retains a 1 percent interest in all securities acquired before the increase. ABC then acquires Securities Y and Z and later distributes Security X to A in a current distribution. Immediately before the distribution, the securities held by ABC had the following fair market values, adjusted tax bases, and unrecognized gain or loss:

(ii) If ABC had sold the securities for fair market value immediately before the distribution to A, the partnership would have recognized $600 of net gain ($500 gain on Security X plus $200 gain on Security Y minus $100 loss on Security Z). A's distributive share of this gain would have been $7 (1 percent of $500 gain on Security X plus 2 percent of $200 gain on Security Y minus 2 percent of $100 loss on Security Z).

(iii) If ABC had sold the remaining securities immediately after the distribution of Security X to A, the partnership would have $100 of net gain ($200 gain on Security Y minus $100 loss on Security Z). A's distributive share of this gain would have been $2 (2 percent of $200 gain on Security Y minus 2 percent of $100 loss on Security Z). As a result, the distribution resulted in a decrease of $5 in A's distributive share of the net gain in ABC's securities ($7 net gain before distribution minus $2 net gain after distribution).

(iv) Under paragraph (b) of this section, the amount of the distribution of Security X that is treated as a distribution of money is reduced by $5. The distribution of Security X is therefore treated as a distribution of $995 of money to A ($1000 fair market value of Security X minus $5 reduction).

(i) A and B form partnership AB as equal partners. A contributes nondepreciable real property with a fair market value and adjusted tax basis of $100.

(ii) AB subsequently distributes Security X with a fair market value of $120 and an adjusted tax basis of $90 to A in a current distribution. At the time of distribution, the basis in A's interest in the partnership is $100. The amount of the distribution that is treated as money is reduced under section 731(c)(3)(B) and paragraph (b)(2) of this section by $15 (one-half of $30 net gain in Security X). As a result, A recognizes $5 of gain under section 731(a) on the distribution (excess of $105 distribution of money over $100 adjusted tax basis in A's partnership interest).

(iii) A's adjusted tax basis in Security X is $95 ($90 adjusted basis of Security X determined under section 732(a)(1) plus $5 of gain recognized by A by reason of section 731(c)). The basis in A's interest in the partnership is $10 as determined under section 733 ($100 pre-distribution basis minus $90 basis allocated to Security X under section 732).

(i) A and B form partnership AB as equal partners. A contributes nondepreciable real property, with a fair market value of $100 and an adjusted tax basis of $10.

(ii) AB subsequently distributes Security X with a fair market value and adjusted tax basis of $40 to A in a current distribution and, as part of the same distribution, AB distributes Property Z to A with an adjusted tax basis and fair market value of $40. At the time of distribution, the basis in A's interest in the partnership is $10. A recognizes $30 of gain under section 731(a) on the distribution (excess of $40 distribution of money over $10 adjusted tax basis in A's partnership interest).

(iii) A's adjusted tax basis in Security X is $35 ($5 adjusted basis determined under section 732(a)(2) plus $30 of gain recognized by A by reason of section 731(c)). A's basis in Property Z is $5, as determined under section 732(a)(2). The basis in A's interest in the partnership is $0 as determined under section 733 ($10 pre-distribution basis minus $10 basis allocated between Security X and Property Z under section 732).

(iv) AB's adjusted tax basis in the remaining partnership assets is unchanged unless the partnership has a section 754 election in effect. If AB made such an election, the aggregate basis of AB's assets would be increased by $70 (the difference between the $80 combined basis of Security X and Property Z in the hands of the partnership before the distribution and the $10 combined basis of the distributed property in the hands of A under section 732 after the distribution). Under section 731(c)(5), no adjustment is made to partnership property under section 734 as a result of any gain recognized by A by reason of section 731(c) or as a result of any step-up in basis in the distributed marketable securities in the hands of A by reason of section 731(c).

(i) A and B form partnership AB. A contributes Property A, nondepreciable real property with a fair market value of $200 and an adjusted basis of $100 in exchange for a 25 percent interest in partnership capital and profits. AB owns marketable Security X.

(ii) Within five years of the contribution of Property A, AB subsequently distributes Security X, with a fair market value of $120 and an adjusted tax basis of $100, to A in a current distribution that is subject to section 737. As part of the same distribution, AB distributes Property Y to A with a fair market value of $20 and an adjusted tax basis of $0. At the time of distribution, there has been no change in the fair market value of Property A or the adjusted tax basis in A's interest in the partnership.

(iii) If AB had sold Security X for fair market value immediately before the distribution to A, the partnership would have recognized $20 of gain. A's distributive share of this gain would have been $5 (25 percent of $20 gain). Because AB has no other marketable securities, A's distributive share of gain in partnership securities after the distribution would have been $0. As a result, the distribution resulted in a decrease of $5 in A's share of the net gain in AB's securities ($5 net gain before distribution minus $0 net gain after distribution). Under paragraph (b)(2) of this section, the amount of the distribution of Security X that is treated as a distribution of money is reduced by $5. The distribution of Security X is therefore treated as a distribution of $115 of money to A ($120 fair market value of Security X minus $5 reduction). The portion of the distribution of the marketable security that is not treated as a distribution of money ($5) is treated as other property for purposes of section 737.

(iv) A recognizes total gain of $40 on the distribution. A recognizes $15 of gain under section 731(a)(1) on the distribution of the portion of Security X treated as money ($115 distribution of money less $100 adjusted tax basis in A's partnership interest). A recognizes $25 of gain under section 737 on the distribution of Property Y and the portion of Security X that is not treated as money. A's section 737 gain is equal to the lesser of (i) A's precontribution gain ($100) or (ii) the excess of the fair market value of property received ($20 fair market value of Property Y plus $5 portion of Security X not treated as money) over the adjusted basis in A's interest in the partnership immediately before the distribution ($100) reduced (but not below zero) by the amount of money received in the distribution ($115).

(v) A's adjusted tax basis in Security X is $115 ($100 basis of Security X determined under section 732(a) plus $15 of gain recognized by reason of section 731(c)). A's adjusted tax basis in Property Y is $0 under section 732(a). The basis in A's interest in the partnership is $25 ($100 basis before distribution minus $100 basis allocated to Security X under section 732(a) plus $25 gain recognized under section 737).