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СпутникиРНSpaceXРоскосмосNASAIn a significant development for nonresident investors and private equity structures, the California Office of Tax Appeals (OTA) held that gain attributable to IRC section 751(a) “hot assets,” such as unrealized receivables and inventory items, remain part of the sale of a partnership interest. As the sale of an intangible interest, the sale of partnership interest is generally sourced to an individual taxpayer’s state of residence under California Revenue and Taxation Code section 17952.
FTB’s Position
The California Franchise Tax Board (FTB) argued that gain attributable to IRC section 751(a) “hot assets” from the sale of a partnership interest should be sourced differently from the remaining gain. According to FTB, those amounts represented a deemed sale of the partnership’s underlying business assets, and therefore must be sourced using the California apportionment factors of the entity that was sold, i.e., on a market basis.
OTA’s Analysis
Relying on the D.C. Circuit’s decision… Read the complete article here...
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California OTA Rejects FTB's IRC Section 751 Partnership Sourcing Theory
Thursday, October 15, 2026
In a significant development for nonresident investors and private equity structures, the California Office of Tax Appeals (OTA) held that gain attributable to IRC section 751(a) “hot assets,” such as unrealized receivables and inventory items, remain part of the sale of a partnership interest. As the sale of an intangible interest, the sale of partnership interest is generally sourced to an individual taxpayer’s state of residence under California Revenue and Taxation Code section 17952.
FTB’s PositionThe California Franchise Tax Board (FTB) argued that gain attributable to IRC section 751(a) “hot assets” from the sale of a partnership interest should be sourced differently from the remaining gain. According to FTB, those amounts represented a deemed sale of the partnership’s underlying business assets, and therefore must be sourced using the California apportionment factors of the entity that was sold, i.e., on a market basis.
OTA’s AnalysisRelying on the D.C. Circuit’s decision in Rawat v. Commissioner, OTA concluded that IRC section 751(a) alters the character of gain, converting a portion of the gain from capital to ordinary income, but does not alter the nature of the transaction itself. The taxpayers sold partnership interests, not inventory or receivables. As a result, OTA found there was no actual or deemed sale of partnership assets giving rise to distributive-share income sourced under California’s partnership apportionment rules for income from operating a trade or business.
Taxpayer TakeawaysThe decision is particularly significant because OTA expressly declined to follow FTB Legal Ruling 2022-02, which set forth the FTB’s position. The decision may provide nonresident investors, private equity funds, and other taxpayers with a meaningful basis to challenge assessments premised on Legal Ruling 2022-02 and may be particularly relevant in transactions involving operating partnerships with significant California business activity but nonresident owners.