What happens if a distribution exceeds a partner's basis in a partnership?

When a distribution from a partnership exceeds a partner's basis in the partnership, it is considered to be treated as a taxable capital gain. This outcome occurs because the basis represents the partner's investment in the partnership. When distributions exceed that basis, it indicates that the partner is receiving more than what they have invested, leading to a gain of the excess amount.

This capital gain is recognized for tax purposes in the year of the distribution. The tax treatment applies because the excess distribution has effectively returned to the partner a profit from their investment rather than a return of their original capital. Thus, this profit is subject to capital gains tax rather than being sheltered from taxation or treated as ordinary income.

The other choices do not apply to the situation correctly. For instance, taxability is not protected and simply receiving the distribution does not alter the tax nature of a gain. Similarly, the idea of taxing it at a lower rate or treating it as ordinary income misrepresents how distributions and gains are categorized under tax law. A distribution exceeding basis directly leads to a capital gain recognition, ensuring the accuracy of the tax implications for such transactions.