What Is a Technical Termination of a Partnership?

A technical termination of a partnership was a specific event under former U.S. tax law that treated a partnership as closed for tax purposes after a significant ownership change, even if business operations continued. The trigger for this event was the sale or exchange of 50% or more of the total interests in both the partnership’s capital and its profits within a 12-month period.

The Tax Cuts and Jobs Act of 2017 (TCJA) repealed the technical termination rule for partnership tax years beginning after December 31, 2017. This rule is no longer in effect for current partnership transactions. However, knowledge of the historical rule remains relevant for amending prior-year returns or understanding the context behind current partnership termination rules.

The Pre-2018 Trigger for Technical Termination

Under former Internal Revenue Code (IRC) Section 708, a partnership was forced into a technical termination if there was a sale or exchange of 50% or more of the total interest in both partnership capital and profits within any 12-month period. This rule was mechanical, and the termination was automatic if the ownership threshold was met, regardless of the partners’ intent.

The definition of a “sale or exchange” was specific and did not include all transfers. For instance, the disposition of a partnership interest by gift, bequest, or inheritance did not count toward the 50% threshold. A liquidation of a partner’s interest by the partnership itself was also not considered a sale or exchange for this purpose.

For example, if one of two equal partners sold their entire 50% interest to a new person, a technical termination would have occurred. The same result would happen if multiple, smaller sales within a 12-month window added up to 50% or more of the total capital and profits interests. If a 30% partner sold their interest in March and a 25% partner sold their interest in October of the same year, a technical termination would be triggered in October.

Consequences of a Pre-2018 Technical Termination

The tax effects of a technical termination created administrative burdens. The regulations prescribed a “deemed distribution and recontribution” model. Under this framework, the old partnership was treated as if it distributed all of its assets and liabilities to the partners. Immediately following this, those same partners were treated as contributing the assets and liabilities back into a newly formed partnership.

One of the immediate consequences was the forced closure of the partnership’s taxable year on the date of the terminating sale, which required filing a short-year tax return. Any tax elections the old partnership had made, such as its method of accounting, ceased to be effective. The new partnership had to make its own elections.

Another consequence was the impact on depreciation. Because the assets were deemed recontributed to a new partnership, they were treated as newly placed in service. This forced a reset of depreciation schedules for the partnership’s property, such as buildings and equipment, often leading to smaller annual depreciation deductions.

Required Tax Filings for a Pre-2018 Termination

A partnership that underwent a technical termination was required to file two short-year partnership returns (Form 1065) for the calendar year in which the termination occurred.

The first was a final return for the terminated partnership. This return covered the short taxable year that ended on the date of the sale or exchange that triggered the termination. On this Form 1065, the “Final Return” box had to be checked.

The second return was an initial return for the new, post-termination partnership, covering the short taxable year from the day after the termination through the partnership’s normal year-end. For this Form 1065, the “Initial Return” box needed to be checked. Both returns would use the same Employer Identification Number (EIN) as the partnership’s legal entity did not change, only its tax identity.

Partnership Terminations After the TCJA Repeal

Following the repeal of the technical termination rule by the TCJA, partnership terminations are much simpler for tax years beginning after December 31, 2017. A sale or exchange of 50% or more of partnership interests no longer triggers a termination for tax purposes. The partnership’s tax existence continues without interruption, and its tax year, depreciation schedules, and tax elections remain in place.

This does not mean a partnership can no longer terminate for tax purposes, as the TCJA left the rules for an “actual” termination intact. An actual termination occurs only when the business operations of the partnership are discontinued. This also requires that no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.

An actual termination happens when a partnership liquidates completely, pays off its debts, distributes its remaining assets, and winds down all of its affairs. The partnership’s tax year ends on the date the winding up of its affairs is completed. This event is driven by the cessation of business activity, not by a change in ownership.