Our partnership is distributing a mortgaged building to one partner. Can another partner owe tax without receiving cash?
Yes, it is possible. When a partnership transfers an encumbered building to one partner, the other partners can lose their shares of the partnership debt. Section 752 generally treats a decrease in a partner's liability share as a deemed money distribution, even if that partner receives no cash or property. If the net deemed distribution exceeds that partner's adjusted outside basis, Section 731 can produce gain. The answer depends on the debt allocation immediately before and after the transfer, not on the mortgage face amount alone. The IRS partnership guidance explains both the basis adjustment and the liability-assumption rules.
This question often arises when owners divide a commercial-property portfolio, one sponsor takes a building in a buyout, or an LLC taxed as a partnership winds down. A deed, lender consent, and a manager's estimate of each owner's capital account do not by themselves settle the federal return position. Model every owner's debt share and outside basis before the deed and Forms 1065 and K-1 are finalized.
Why the partner who receives nothing can still have gain
Start with the partnership's liability schedule. A nonrecourse mortgage is not automatically divided by ownership percentage in every case: minimum-gain and contributed-property rules can alter the allocation. Recourse debt turns on economic risk of loss, including valid guarantees and reimbursement rights. The IRS's Section 752 discussion distinguishes these categories. When the building and its loan leave the partnership, compare each partner's liability share just before and just after the transaction. Increases and decreases associated with the same transaction generally must be netted; do not report the full loan as cash to each owner.
For the owner taking the building, property subject to a liability is treated under the Section 752 rules as involving an assumed liability to the extent described by the IRS. That owner's own debt-share decrease and personal assumption may offset. For a different owner, the prior partnership-debt share may disappear with no offsetting assumption. Section 752(b) then treats that net decrease as money distributed to that owner. The partner K-1 instructions state that deemed money above outside basis is gain. Tax-basis capital shown on a K-1 is not a substitute for the owner's adjusted outside-basis workpaper; it can omit liability basis and other owner-level adjustments.
Worked example: a partner receives no check
Assume a two-owner real-estate partnership owns a building with a $1 million mortgage. Its documented Section 752 workpaper allocates $500,000 of that debt to each partner immediately before a distribution. The partnership transfers the building, subject to the mortgage, to Partner A, and the lender and transaction documents support A taking the debt. Assume the partnership has no other debt, Partner B does not assume or guarantee this loan after the transfer, no cash or other property goes to B, and no other same-transaction liability changes offset B's reduction. B's share falls from $500,000 to zero. The resulting $500,000 deemed money distribution is tested against B's properly adjusted outside basis immediately before the event.
If B's outside basis is $300,000 after all applicable pre-distribution adjustments, the simplified Section 731 calculation produces $200,000 of gain despite B receiving no cash. It does not mean the partnership sold the building for $1 million or that A automatically recognizes the same gain. A's property basis, debt assumption, continuing partnership interest, and any Form 7217 filing require separate computations. Actual loan allocations may differ sharply from the assumed 50/50 split, and a redemption, disguised sale, contributed-property rule, or later property sale can change the result. The numbers illustrate a risk to test, not a transaction recommendation or projected tax bill.
Decision sequence before signing the deed
- Identify the legal transaction. Is this a current property distribution, complete liquidation of one partner's interest, purchase of an interest by another owner, or a planned transfer to a buyer? The agreement, consideration, and deed must tell the same story. A direct co-owner purchase belongs in an interest-sale analysis, not automatically in the distribution rules.
- Reconstruct liabilities for every owner. Obtain the note, lender consent, guarantees, security, reimbursement agreements, and before-and-after debt allocations. Test recourse versus nonrecourse treatment and net same-transaction increases against decreases under Section 752. A bank's release of one guarantor may matter as much as the deed.
- Roll forward each owner's outside basis. Reconcile prior K-1s, contributions, income, loss, distributions, transferred interests, and liability shares through the distribution date. Compare each owner's net deemed money with their own adjusted basis; do not use a property appraisal or tax-basis capital as the answer.
- Test special rules and filing paths. Review Section 704(c)(1)(B) if a different partner contributed the property in the last seven years; Section 737 if the recipient contributed appreciated property; Section 751(b) hot assets; disguised-sale or exchange substance; and any Section 754/734(b) adjustment. The recipient of property generally considers Form 7217 with their annual return for distributions subject to Section 732. Coordinate Form 1065, every affected K-1, owner returns, and state differences.
Documents and failure points for the return review
Bring the operating and distribution agreements; property deed and title report; note, lender release and guarantee documents; asset tax-basis and depreciation schedules; property valuation; three years of Forms 1065 and K-1; owner outside-basis workpapers; Section 704(c), 754, 743(b), and 734(b) schedules; and any draft sale or buyout documents. Reconcile the property's loan balance to the partnership's year-end liability reporting and each owner's debt share on the actual transfer date. If cash, other property, or debt changes occur as part of one plan, keep one transaction timeline rather than disconnected entries.
Common errors are counting the full mortgage as income to the property recipient, missing gain for a nonrecipient partner whose debt share falls, assigning nonrecourse debt purely by ownership percentage without checking the regulations, and treating negative tax-basis capital as proof of gain. Another is assuming a generally nonrecognition property distribution overrides the special seven-year contributed-property and hot-asset rules. Publication 541, the Form 1065 instructions, and the Form 7217 instructions provide the starting federal rules; documents and transaction substance determine the actual result.
AE can reconcile the partnership's property and debt schedules, model each owner's Section 752 and outside-basis position, and coordinate the entity and owner return review with legal counsel before the distribution is fixed. For a cash-out refinance rather than a property transfer, see our refinance-distribution guide. For general property distributions, see the in-kind distribution overview; for an owner buyout, see the Section 736 analysis. This page is general federal tax information, not advice on a particular deed, lender obligation, or state-law transfer.