New York Concludes that Loss on Liquidation of Partnership is Not New York Source Income

New York has a unique rule for nonresident individuals regarding the sourcing of gain/loss on the sale of equity interest in certain entities that own real estate located in the state, and this advisory opinion highlights a potential opportunity to avoid New York tax on the sale of that equity interest.

By: Jess Johannesen, SALT Manager

For state income tax purposes, when an individual sells or transfers an intangible asset, including a partnership interest, any gain or loss is typically sourced to the individual’s state of residence, but that may not always be the case. For example, in New York, income, gains, losses and deductions attributable to the ownership of any interest in real or tangible personal property in the state constitutes New York source income.[1] Accordingly, if you are a nonresident that sells real property located in New York, the gain from that sale is New York source income subject to New York’s personal income tax. This rule is generally uniform among the states.

New York is unique in that it amended this rule in 2009, defining the term “real property located in this state,” to include an interest in certain entities (such as a partnership and other pass-through entities) that own real property in the state when the value of such real property exceeds fifty percent of all the entity’s assets on the date of such sale or exchange.[2]  With this rule in place, New York source income now includes gains or losses from the sale of a partnership interest if that partnership owned enough real property in New York.

A recent New York Advisory Opinion addressed whether loss from the liquidation and dissolution of a partnership is considered New York source under this rule.[3] In the opinion, the Petitioner was a limited partnership with thousands of limited partners, many of whom were nonresident individuals. The Petitioner invested in real estate and owned land and improvements in many states, including a building in New York that the Petitioner owned and actively managed.

The Petitioner sold its New York building on November 1, 2016, and the building was the last material asset it sold (the Petitioner still held undistributed cash).  As a result of the sale, the Petitioner recognized a taxable gain and paid New York estimated taxes associated with the sale on behalf of its partners as required by the state. After the building sold, the Petitioner wound up its operations and liquidated. The proceeds from the liquidation were distributed on November 2, 2016, because November 1 was a bank holiday in the country where many of the limited partners resided. Upon the Petitioner’s liquidation, each partner was expected to recognize a capital loss under federal tax law.

The Petitioner asked whether the loss on liquidation would be considered New York source. New York’s Advisory Opinion concluded that the loss was, in fact, not New York source since the Petitioner did not own any New York real property on November 2, 2016 (when the partnership was liquidated and the net proceeds were distributed by the partnership to the partners).  Just one day made all the difference in this ruling as the partners recognized gains on their nonresident returns attributed to the sale of the building in New York, but the losses realized on the liquidation of their partnership interests could not offset any of the gains.

This Advisory Opinion highlights one of New York’s more unique rules for nonresidents, and the conclusion illustrates the importance of considering state income tax implications at all phases of your business’s lifecycle.  The ruling also provides a potential planning opportunity in cases where gain, instead of loss, may be recognized on the liquidation, if the entity is able to dispose of its New York real estate prior to such liquidation, even one day before.

Aprio’s SALT team is experienced with multi-state income tax issues and understands that unique rules, like the one explained above, may exist and can impact the way business transactions should be structured in order to minimize taxes. We can advise you on the multi-state income tax consequences of your proposed transactions and identify opportunities to restructure those transactions to achieve a more favorable state income tax result. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen, SALT Manager at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the July 2020 SALT Newsletter.

[1] N.Y. Tax Law §631(b)(1)(A)

[2] N.Y. Tax Law §631(b)(1)(A)(1). Only assets that the entity owner for at least two years prior to the date of the sale or exchange are taken into account for this purpose.

[3] N.Y. Advisory Opinion TSB-A-20(3)I, 02/10/2020.