Blog · 15 October 2026

Section 751 Hot Assets and California Nonresident Partnership Interest Sales: What the OTA’s Burch Ruling Means for US CPA Firms

By Keshav Bansal, CA

When a nonresident sells a partnership interest, Section 751 hot assets decide how much of the gain is ordinary income. Do they also decide where that gain is sourced? California’s Office of Tax Appeals (OTA) has now said no. In the consolidated Appeals of J. Burch, J. Carden and K. Carden (OTA Case Nos. 230112266 & 230112267, issued July 24, 2026; posted as 2026-OTA-527P, “Pending Precedential”), OTA declined to follow Franchise Tax Board (FTB) Legal Ruling 2022-02. It held that the nonresidents’ entire gain on a California nonresident partnership interest sale, including the §751(a) ordinary-income portion, is sourced under Revenue and Taxation Code (R&TC) §17952 and is not California-source income. Ed Zollars, CPA, covered it in Current Federal Tax Developments (October 8, 2026). For US CPA firms, it is a clean lesson in character versus source.

Section 751 hot assets in one paragraph

IRC §741 says gain or loss on the sale of a partnership interest is capital gain or loss, “except as otherwise provided in section 751.” Section 751(a) supplies that exception. The part of the amount realized that is attributable to the partnership’s unrealized receivables or inventory items “shall be considered as an amount realized from the sale or exchange of property other than a capital asset.” In practice, that is ordinary income. The rule stops partners from converting ordinary income into capital gain by selling the interest instead of the assets. Under §751(c), unrealized receivables also include recapture amounts such as §1245 depreciation recapture. In entity-versus-aggregate terms, §741 treats the interest as one capital asset, while §751(a) looks through to what the partnership holds to get the character right.

What happened in Burch and Carden

Per OTA’s findings, the appellants were California nonresidents at all relevant times. They owned interests in JCB Investments, LLC, an investment partnership that held about 28% of Tory Burch LLC. Tory Burch LLC was also a partnership and ran a unitary business inside and outside California. In 2012 and 2013, JCB sold portions of its Tory Burch interests. Part of the gain was capital under §741, and part was ordinary under §751(a). The appellants reported their shares as non-California source under R&TC §17952.

On audit, FTB split each sale in two. It treated the §751(a) portion as a distributive share of Tory Burch’s apportionable business income from a deemed sale of hot assets, sourced under Regulation 17951-4(d) using Tory Burch’s California apportionment percentages (13.5581% for 2012 and 16.0753% for 2013, per the opinion). It agreed that the §741 remainder was not California-source. The resulting adjustments were a proposed $2,535,814 reduction of Mr. Burch’s 2013 net operating loss and $1,507 of additional 2012 tax, plus interest, for the Cardens. The panel (Administrative Law Judge Kenneth Gast, with Judges Huy “Mike” Le and Hans Famularo concurring) reversed FTB’s actions in full.

Why OTA rejected FTB’s hot-asset sourcing

• Rawat was “highly persuasive.” OTA followed Rawat v. Commissioner, 108 F.4th 891 (D.C. Cir. 2024). There, the D.C. Circuit held that a foreign seller’s §751(a) gain tied to partnership inventory was not U.S.-source. Section 751(a) changes the character of the gain, but “it does not change the fact that [the taxpayer] sold a partnership interest,” not inventory (as quoted by OTA).
• Computation is not a deemed sale. The hypothetical-sale math in Treas. Reg. §1.751-1(a)(2) measures how much of the gain is ordinary. It does not recast the transaction. OTA contrasted §751(b) and §338, which expressly treat certain transactions as sales of the underlying property—language §751(a) lacks.
• California’s statutes don’t say otherwise. Regulation 17951-4(d) covers a nonresident partner’s “distributive share” of unitary partnership income, not the sale of a partnership interest. R&TC §17952 sources a nonresident’s income from intangible property to the owner unless the property has acquired a California business situs. If FTB wants a different result, OTA said, it is free to ask the Legislature for a statutory change.
• Prior cases distinguished. Appeal of Bense (1979, residents) and Appeal of Smith (2023-OTA-069P, a unitary holding-entity case) did not help FTB, which did not argue JCB and Tory Burch were unitary.

Character vs sourcing: the takeaway

The same gain can be ordinary for federal (and California) character purposes and still be non-California source for a nonresident. Character drives federal rates and capital-loss limits. Source drives which state gets to tax a nonresident. Compare federal law for foreign sellers: after the year in Rawat, Congress enacted §864(c)(8) (for dispositions on or after November 27, 2017), an explicit deemed-sale rule. Without that kind of express statute, Burch says the §751 computation alone does not move the source.

Limits and status to flag for clients

• Not yet final precedent. As of October 15, 2026, OTA’s 2026 precedential-opinions page lists the case as “Pending Precedential.” Under 18 CCR §30502, that label opens a public-comment window. OTA then designates the opinion Precedential or Nonprecedential no sooner than 35 and no later than 60 days after posting.
• Rehearing is a two-way street. OTA’s “Disagreeing with OTA” guide and 18 CCR §30505 state that an opinion becomes final 30 days after issuance unless a party files a petition for rehearing. The guide says either the taxpayer or the tax agency may file one. We have not seen a public report on whether FTB filed one here.
• Unitary and situs facts still matter. The opinion distinguishes cases where the holding entity and the operating partnership are unitary, as in Smith, and §17952 itself taxes interests with a California business situs.
• Legal Ruling 2022-02 is still listed on FTB’s site. Don’t assume audits will stop citing it.

A short checklist for US CPA firms

1. For any nonresident selling a partnership or LLC interest, compute the §751(a) ordinary portion separately. Then run a separate state sourcing analysis.
2. Document domicile and whether the interest could have a California business situs under Regulation 17952(c).
3. Map the structure. Is the gain recognized at a holding-entity level that may be unitary with the operating partnership?
4. For open California years where FTB applied Legal Ruling 2022-02, consider protests or claims citing Burch, and track its precedential status.
5. Revisit basis first; see our note on partnership basis and at-risk rules after West. Related: limited partner self-employment tax after Soroban and our state millionaire tax roundup.

Where this fits for Tax Brew readers

Burch doesn’t change how you compute §751 income; it changes the state answer for nonresidents. If your team needs capacity for K-1 reviews, nonresident return prep or partnership workpapers, outsourced tax prep and bookkeeping support for US CPA firms can help. Email info@taxbrewglobal.com.

Sources: California Office of Tax Appeals, Opinion, Consolidated Appeals of J. Burch, J. Carden and K. Carden, OTA Case Nos. 230112266 & 230112267, 2026-OTA-527P (Pending Precedential; date issued July 24, 2026); OTA, 2026 Precedential Franchise & Income Tax Opinions page; OTA, “Disagreeing with OTA” (April 2025); 18 CCR §§30502, 30505; FTB Legal Ruling 2022-02 (July 14, 2022); IRC §§741, 751, 864(c)(8); Cal. R&TC §17952 and 18 CCR §17952; Ed Zollars, CPA, Current Federal Tax Developments (Oct. 8, 2026). General information, not tax or legal advice. Sources as of 15 October 2026.