TAX EFFECT OF A CHARGING ORDER
A creditor who obtains a charging order against a partnership interest runs the risk of being taxed on income of the partnership, even though such income is not distributed. For example, a partnership owns an apartment building with a tax basis of $100,000. It sells the building for $1,000,000 in 1993. The partnership has a taxable gain of $900,000. Since the partnership is not itself a taxpaying entity, the taxable gain is allocated among the partners according to their respective ownership percentages. The partners receive this allocation of income regardless of whether the partnership actually distributes any cash.
There is some authority for the position that a creditor with a charging order is treated as a partner for purposes of receiving allocations of partnership income or loss. Revenue Ruling 77-137, 1977-1 CB 178. Under the facts which we have posed, a creditor with a charging order against a 50% partnership interest, for a judgment of $100,000, would have taxable income from the partnership of $450,000. Again, this is so even though the partnership holds onto the proceeds from the sale and nothing is distributed to the creditor or the other partners. Since the creditor will have to pay a tax liability of over $200,000 in attempting to collect a judgment of $100,000, the charging order would be a very unsatisfactory method of collecting this debt. The same result would be reached if the creditor obtained a foreclosure on the debtors partnership interests rather then a charging order.