Many years ago, Jane Jackson and her sister Laura purchased land in Burlington, VT. At that time, they used capital they obtained from placing second mortgages on their homes, and they began their investing as Jackson Partnership. Because of the prosperity and growth of the area and because they have shown an ability to select prime real estate for others to develop their investments have flourished. They have acquired a great amount of land over the years and have sold some to developers.

Their current tax year has just closed, and the partnership has the following balance sheet:

Partnership's Basis

Fair Market Value

Assets:

Cash

$160,000

$160,000

Accounts receivable

$72,000

$72,000

Land held for investment

$248,000

$808,000

Total

$480,000

$1,040,000

Liabilities and Capital:

Mortgages

$320,000

$320,000

CapitalJane

$80,000

$360,000

CapitalLaura

$80,000

$360,000

Total

$480,000

$1,040,000

Jane and Laura each have a basis in their partnership interest of $240,000, including their share of liabilities. The economic risk of loss from the liabilities is shared equally between them. Unfortunately, Jane suffered a serious stroke last summer. On the advice of her doctor, Jane wants to retire from all business activity and terminate her interest in the partnership. She is interested in receiving some cash upfront but is not averse to receiving part of her payment over time.

You have been asked to advise the sisters on how to terminate Jane's interest in the partnership. Jane and Laura have come up with several possibilities, and they would like you to explain which would be most beneficial for Jane from a tax perspective. Laura understands that the resulting choice may not be the best option for her. They have considered the following possibilities:

Laura has significant personal cash reserves and could purchase Jane's interest directly. The sisters worry, however, that this option would most likely deplete almost all of Laura's cash reserves, and they are concerned about any cash needs Laura might have in the future. They would prefer to have Jane receive $96,000 up-front, plus $88,000 annually for a period of 3 years. Jane would receive interest at a market rate on the outstanding debt as well. While this alternative would qualify for installment reporting, the installment sale rules for related parties would apply.

Another option would be for Jane's interest to be retired by the partnership. The sisters have pondered the option of paying Jane $120,000 up-front plus 50% of partnership profits over a period of 3 years. As an alternative, they could plan for Jane to have a $120,000 payment up-front and a guaranteed annual disbursement of $80,000 per year for a period of 3 years. With these 2 options, the sisters anticipate that the dollar amounts to be received by Jane would be approximately the same for the next 3 years. Jane would receive interest at a market rate on any deferred payments as well.

A long-time friend of the family, Gary Roberts, has conveyed an interest in buying Jane's interest for $360,000 in cash immediately. Laura and Jane are comfortable that they could work well together.

Jane has significant amounts of money in savings accounts and in stocks and bonds that have a ready market. She has no direct investment in any other businesses. Assume that, for each year, Jane's ordinary tax rate is 33% and her capital gains tax rate is 18.8% (the 15% capital gain rate for her tax bracket plus the 3.8% rate on net investment income).

summarize the advice you would give the 2 sisters on the options that they have considered.