In a proportionate nonliquidating distribution of a capital asset
Nonetheless, there are transactions that can break the equality of aggregate inside and aggregate outside basis.
But it quickly becomes problematic when one if the two partners wants a greater share of early receipts in exchange for a lower share of back-end gains.We have: The partnership‟s only asset has appreciated from its cost of $60 to its current value of $340.If the asset is now sold, there will be a tax gain of $280, allocable equally between the partners. Thus, each partner must include gain of $140 on his individual return, and the books will become: If the partnership now liquidates, it will distribute cash of $120 to P and $240 to Q, giving them each a total return of $240.And, perhaps more importantly, the accrued gain must be taxed equally to P and to Q because, by booking it into the partners‟ capital accounts equally, they are now bound to share the tax gain in the same manner as they shared the book gain under applicable Treasury regulations. Surprisingly, a restatement of the capital accounts is permitted but not required under current law, presenting a variety of tax minimizing opportunities. But to understand the importance of the restatement, consider what would happen if the capital accounts were not restated and then, after P‟s profit share had been reduced to one-third, Blackacre were sold for $340.The books of the partnership would become: These totals show P with a capital account balance of only $73, which means that if the partnership were to liquidate immediately, P would be entitled to cash of $73 (and the remaining cash of $287 would go to Q). When coupled with the prior cash distribution to P of $120, that means P‟s total return from the venture would be $193.Consider first the simplest case in which an inside basis adjustment under §734(b) is mandated because a distribution of cash causes income recognition to the distribute.
For example, suppose that P and Q form the PQ partnership by contributing cash of $100 each.
Indeed, the basis adjustments provided by the section 754 election are so well designed – and the equality been aggregate inside and aggregate outside basis so important – that commentators have called for making these basis adjustments mandatory rather than optional. When an election under section 754 is made, the electing partnership becomes subject to two basis adjustment provisions: (1) section 734(b), providing for certain inside basis adjustments upon the occurrence of specified triggering distributions of cash or property from the partnership; and (2) section 743(b), providing for certain inside basis adjustments upon the sale or exchange of a partnership interest.
The regulations specifying the manner of making these adjustments have recently undergone major revisions, with the greatest attention focused on the section 743(b) adjustments.
Because aggregate inside basis and aggregate outside basis each represent the after-tax (and debt financed) investment in partnership assets, they should equal one another. They start equal by reason of the basis rules applicable to contributions of property (including the debt allocation rules of section 752), and they will in general remain equal throughout the life of the partnership. The examples presented throughout this Article do not consider the case of partnership indebtedness, although adding debt to the transaction should not change the analysis.
When they are not equal, astute taxpayers can exploit the difference. Suppose, for example, that aggregate outside basis is higher than aggregate inside basis.
This means that the partnership’s basis in Blackacre will increase from $60 to $80.  Prior to the distribution, Q‟s distributive share of the appreciation in the partnership‟s assets was $140 (half of the $280 increase in value), and after the transaction, that share remains the same.