Are partnership distributions taxable?

What counts as a distribution

Publication 541 lists four kinds: a withdrawal by a partner in anticipation of the current year’s earnings; a distribution of the current or prior years’ earnings not needed for working capital; a complete or partial liquidation of a partner’s interest; and a distribution to all partners in a complete liquidation of the partnership. A distribution is not part of the partner’s distributive share of income or loss. That distinction is the heart of the question: you are taxed on your share of the partnership’s income each year whether or not any cash comes out, and the cash that later comes out is generally a return of basis you already paid tax on. Money withdrawn in anticipation of the year’s earnings is treated as received on the last day of the partnership’s tax year.

When a distribution is taxable

A partner generally recognizes gain on a distribution only to the extent that money, including marketable securities treated as money, exceeds the adjusted basis of the partner’s interest. Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. If property other than marketable securities treated as money is distributed, the partner generally recognizes no gain until the property is sold or otherwise disposed of. The publication’s example: Jo’s basis is $14,000 and she receives $8,000 cash and land with an adjusted basis of $2,000 and a market value of $3,000. The cash is under her basis, so no gain. Her basis falls to $4,000 ($14,000 minus $8,000 plus $2,000). Try other numbers above: with a $5,000 basis and $8,000 cash, the calculator shows $3,000 of gain and a basis of zero.

Property you receive

Unless the partner’s entire interest is liquidated, the partner’s basis in distributed property other than money is the partnership’s adjusted basis immediately before the distribution, but never more than the adjusted basis of the partner’s interest reduced by any money received in the same transaction. Emily has a $30,000 interest basis and receives property with a $20,000 partnership basis and $4,000 cash: her property basis is $20,000. Steve has a $10,000 interest basis and receives $4,000 cash and property with an $8,000 partnership basis: his property basis is capped at $6,000 ($10,000 minus $4,000). The holding period of the distributed property includes the period the partnership held it and, if a partner contributed it, that partner’s time as well.

Complete liquidations and dividing basis

In a complete liquidation of a partner’s interest, the basis of property received is the adjusted basis of the interest reduced by money distributed in the same transaction. If several properties are received, that basis is divided: first to unrealized receivables and inventory, each at the partnership’s adjusted basis, scaled down if the total is too high; the rest to other properties at the partnership’s basis, adjusted up or down, with increases going first to appreciated properties and decreases first to depreciated ones. In the publication’s example, Eun has a $55,000 basis and receives property A (partnership basis $5,000, value $40,000) and property B ($10,000 basis, $10,000 value). After assigning $5,000 and $10,000 there is a $40,000 increase: $35,000 goes to A for its appreciation, and the last $5,000 is split $4,000 and $1,000 by value, giving bases of $44,000 and $11,000.

Losses on distributions

A partner does not recognize a loss on a distribution unless three conditions hold: the basis of the interest exceeds the distribution, the partner’s entire interest is liquidated, and the distribution is in money, unrealized receivables or inventory items. Otherwise the unused basis is carried into the property received, as the liquidation rules below describe.

Exceptions that create gain anyway

Several rules can tax a distribution even when money is below basis. A distribution of unrealized receivables or substantially appreciated inventory in exchange for part of a partner’s interest in other property, or the reverse, can be treated as a sale or exchange. Inventory has appreciated substantially when its fair market value is more than 120% of the partnership’s adjusted basis. If the partner contributed appreciated property in the seven years before a distribution of other property, the partner generally recognizes gain equal to the lesser of two amounts: the excess of the value of the property received over the partner’s interest basis (that basis first reduced, not below zero, by money received), and the partner’s net precontribution gain. Distributing a partner’s own debt back to the partner can produce capital gain or loss to the extent the debt’s value differs from its basis. The publication also describes a special basis adjustment a partner can elect within two years of acquiring an interest.

What the partnership does

A partnership generally recognizes no gain or loss because of distributions to partners, though it may be able to elect to adjust the basis of its undistributed property.

Sources

• IRS Publication 541, Partnerships (12/2025): Partnership Distributions (Effect on partner’s basis, Certain distributions treated as a sale or exchange, Partner’s Gain or Loss, Marketable securities treated as money, Loss on distribution, Distribution of partner’s debt, Net precontribution gain); Partner’s Basis for Distributed Property (Complete liquidation, Basis divided among properties). Read November 2, 2026.

Edition read: Publication 541 (12/2025), Partnerships, as posted on irs.gov. Rules and dollar amounts can change; check the current publication and the Instructions for Form 1065 for your tax year. This page summarizes the publication and does not replace it. The worked examples with named people are the publication's own; the other examples use made-up numbers to show the arithmetic.