A distribution from a partnership is treated as taxable capital gain under which condition?

A distribution from a partnership is treated as taxable capital gain when it exceeds the partner's basis in the partnership. This reflects the underlying tax principle that partners are allowed to recover their investment in the partnership (i.e., their basis) tax-free. Therefore, any distribution received that is greater than the partner's basis represents a realization of gain, which is taxable.

The treatment of distributions is guided by Internal Revenue Code Section 731, which states that a partner recognizes gain only to the extent that the amount of money and the fair market value of property received exceeds the partner's adjusted basis. Thus, the portion of the distribution that exceeds the basis is classified as a capital gain.

In contrast, if a distribution is less than or equal to the partner's basis, no taxable gain arises because the partners effectively withdraw their investment without incurring a tax liability. Additionally, a distribution being classified as a loan does not automatically invoke capital gains treatment unless certain other criteria are met, complicating the tax implications but not aligning it with capital gains status.