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The Tax Implications of Partnership Debt to Equity Conversions

Eric PilcherPartners with debt ties into their business may, at some time, wish to convert that debt to equity. By converting that debt, the partners alter the equation behind their tax basis. As CB&H’s Eric Pilcher describes in a recent issue of Inside Business, a debt to equity conversion could have unforeseen tax consequences.

It is possible an existing partner’s debt conversion may not trigger any income tax consequences. If the converting partner was previously allocated all of the debt, rather than it being split among partners, the converting partner’s tax basis in its partnership interest would not change. Additionally, none of the nonconverting partners’ tax basis would change since the allocation of debt basis is the same after the conversion.

If the converted debt was allocated among partners, the conversion becomes more complex. The converting partner would receive a tax basis increase since, instead of only receiving a portion of the debt, the partner would now receive the entire amount in the form of equity…

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