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 In general, a retiring partner who receives a series of liquidating distributions does not recognize gain until the entire basis in the partnership interest is recovered. Similarly, a loss on a series of liquidating distributions is not recognized until the year in which the retiring partner receives the final liquidating payment. A special choice is available, however, when a retiring partner is to receive a fixed amount of liquidating payments over a period of years. In such a case, the retiring partner may elect to report gain or loss ratably as each liquidating distribution is received. If the election is made, a proportionate share of the partner's basis in the partner's partnership interest is applied against each liquidating payment.

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Example: Jones retires from the ABC partnership. He is to receive a total of $300,000 from the partnership over three years in exchange for his interest in partnership property. His basis in his partnership interest is $180,000. Thus, 60 percent of the total ($180,000 divided by $300,000) is a return of basis and 40 percent of the total is capital gain. (Any substantially appreciated inventory would be subject to tax as ordinary income.)

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