Taxation of Businesses
Phantom Distribution
The amount of phantom distribution, also called a deemed exchange, created is equal to the increase in a partner's share of hot or cold assets after a distribution. (All values refer to values, not bases.)
- If one owns a 40% interest in a partnership that has $1,000 in hot assets, he has a $400 interest in hot assets. If all $1,000 is distributed to him though, he gets a $600 phantom distribution.
Phantom distributions are allocated among the other types assets remaining.
- If one gets a $600 phantom distribution and the partnership has one-third cash and two-thirds capital assets after the distribution, the $600 will be allocated as if he got a $200 distribution of cash, and $400 in capital assets.
The phantom distribution is then exchanged for the actual distribution and taxed as such. This means, gain is recognized on phantom capital assets distributed, the distributee partner's basis is decreased by the basis of the phantom distribution, the partnership recognizes gain on the hot assets (allocated to the other partners), the distributee partner will take a basis in the hot assets in the amount of the hot assets, and the distributee partner will be taxed on the remaining gain of the hot assets when he disposes of them. (26 U.S.C. § 735 if he sells them.)
- Continuing the past examples, it would be treated like the partner got an even distribution of $200 cash, $400 of capital assets with a basis of $200, and $600 of hot assets, and then like he bought the rest of the hot assets with the cash and capital assets. He therefore would recognize gain on the capital assets and decrease his partnership basis by $400 for his phantom distributions. The other 60% interest holders recognize the gain on the hot assets, and the hot assets are also taxed again when the distributee partner realizes them.
There is no phantom distribution if hot assets are evenly distributed among the partners, even if the various hot assets have different bases. This does allow some burden-shifting.