To change a partnership to a sole proprietorship, you dissolve the partnership by buying out the other partner’s interest, file a final Form 1065 with the IRS, cancel the partnership at the state level, and then re-establish the business under your own name using either a new EIN or your Social Security Number. The IRS treats this as two separate events: the end of one entity and the start of another. Each has its own filings, and getting the order wrong can leave you carrying the exiting partner’s liabilities or facing penalties for missed returns.
Read the Partnership Agreement First
Before you negotiate anything, pull the partnership agreement and read the dissolution and buyout clauses. Most agreements set out how much notice a partner must give, how each partner’s interest is valued, and how assets and debts are handled at wind-up. If the agreement calls for 90 days’ written notice, a 30-day close won’t hold up if the buyout is later challenged.
Valuation drives the price. Some agreements use book value, which tends to understate the business. Others require an independent fair market appraisal. If the agreement is silent, both partners have to agree on a method before the deal moves forward. This is the single most common source of post-dissolution litigation between former partners, so document the method in writing.
Structure and Document the Buyout
The transaction at the center of the conversion is your purchase of the other partner’s entire interest. Put it in a written purchase agreement covering price, payment terms, the effective date, and the seller’s representations about the condition of the business. The effective date becomes the partnership’s termination date for tax purposes, so pick it deliberately.
How you allocate the payment matters for both sides. Payments for the departing partner’s share of partnership property are generally treated as distributions. Payments for goodwill or unrealized receivables follow separate rules. In a service partnership where capital is not a material income-producing factor, payments for goodwill are treated as a share of partnership income or a guaranteed payment unless the agreement specifically provides otherwise.1Office of the Law Revision Counsel. 26 USC 736 – Payments to a Retiring Partner or a Deceased Partner’s Successor in Interest That distinction changes whether you can deduct those payments as the continuing partner.
When one of two partners buys out the other and the partnership terminates, the IRS treats the buyer as purchasing partnership assets rather than a partnership interest. Under Revenue Ruling 99-6, both buyer and seller must file Form 8594, Asset Acquisition Statement, allocating the purchase price across the acquired assets.2Internal Revenue Service. Instructions for Form 8594 The IRS matches these forms between the two parties, so the allocations need to line up.
Dissolve the Partnership at the State Level
Once the buyout closes, formally end the partnership with the state. Most states require a Certificate of Cancellation or Statement of Dissolution filed with the Secretary of State. Filing fees generally run from nothing to about $60. Until this is on file, the partnership remains a live entity in state records, with continuing reporting duties and annual fees attached.
Match the effective date on the state filing to the termination date in the buyout agreement. A gap between those two dates leaves the partnership technically alive in between, and both partners can be exposed for anything that happens during that window.
Settle Debts and Notify Third Parties
Every outstanding partnership debt should be resolved before you move forward. The cleanest path is paying obligations off from partnership funds before dissolution. When that isn’t practical, you can assume a debt through a novation, a new agreement with the creditor that substitutes you for the partnership and releases the departing partner. Without a novation, creditors can still chase the exiting partner for old partnership debts, and disputes follow.
If partnership assets secured any loans, confirm liens are properly released or transferred. When a secured loan is paid off, the lender should file a UCC-3 termination statement. When a loan is being assumed, the lender needs to file an amended financing statement showing the new debtor.
Notify vendors, clients, the landlord, and every financial institution the partnership dealt with. Some jurisdictions require a published notice of dissolution to give unknown creditors a final window to file claims. Even where publication isn’t required, written notice to known creditors starts the limitation clock on late claims.
Transfer the Assets and Fix Your Basis
Prepare a final balance sheet and income statement through the termination date. The ending capital accounts tell you what the exiting partner is owed and set the starting point for the sole proprietorship. Move physical assets like equipment, vehicles, and inventory with a bill of sale. Move intangibles like intellectual property, customer lists, and contract rights with a written assignment. These documents prove ownership and support the tax basis you’ll carry into the sole proprietorship.
Your basis in the transferred assets has two pieces. For the portion treated as a liquidating distribution of your own partnership interest, your basis in the distributed property generally equals the adjusted basis of your partnership interest, reduced by any cash you receive in the same transaction.3GovInfo. 26 USC 732 – Basis of Distributed Property Other Than Money For the portion treated as a purchase of the departing partner’s share, your basis is what you paid. Combine the two pieces asset by asset, because that number drives your depreciation and any future gain on sale.
Your holding period for distributed property includes the time the partnership held it.4Internal Revenue Service. Publication 541 Partnerships The tacking applies to the distributed portion, not the purchased portion.
File the Final Partnership Tax Return
The partnership must file a final Form 1065 covering the short tax year that ends on the termination date. Check the “Final return” box and enter the short year dates at the top. The return reports all income, deductions, and credits from the start of the partnership’s tax year through the date the last partner’s interest was acquired.5Internal Revenue Service. Instructions for Form 1065
Issue final Schedule K-1s to every partner, including yourself. Each partner uses their K-1 to complete their individual Form 1040 for the year.5Internal Revenue Service. Instructions for Form 1065
After the final return goes in, send the IRS a letter asking that the partnership’s EIN be deactivated. Include the EIN, the partnership’s legal name and address, and the reason for closing. All outstanding tax obligations must be resolved before the IRS will close the account.6Internal Revenue Service. If You No Longer Need Your EIN
What the Tax Bill Looks Like for Each Partner
The departing partner recognizes a taxable gain if the total cash received in the buyout exceeds the adjusted basis of their partnership interest. Gain on a liquidating distribution is treated as gain from the sale of the partnership interest, which is generally a capital gain.7Office of the Law Revision Counsel. 26 USC 731 – Extent of Recognition of Gain or Loss on Distribution
The exception is what the tax code calls “hot assets,” meaning unrealized receivables and inventory. The portion of the payment attributable to those items is recharacterized as ordinary income.8Office of the Law Revision Counsel. 26 USC 751 – Unrealized Receivables and Inventory Items For a cash-basis business with significant receivables, that shift can meaningfully raise the exiting partner’s tax. Both partners have to agree on the allocation across assets, and their Form 8594 filings must match.
As the continuing owner, you take the blended basis in the retained assets and use it for depreciation on Form 4562.9Internal Revenue Service. Instructions for Form 4562 A basis error at this stage compounds every year through wrong depreciation deductions, and it usually doesn’t surface until an audit or a sale.
Set Up the Sole Proprietorship
Tax Identification
You cannot keep using the partnership’s EIN. The IRS requires a new EIN when someone takes over a partnership and continues it as a sole proprietor.10Internal Revenue Service. When To Get a New EIN If you’ll have employees, a retirement plan, or excise tax obligations, apply for a new EIN through the IRS online application. If none of those apply, you can use your Social Security Number as your taxpayer ID. The old partnership EIN is dead for reporting either way.
Banking and Vendor Accounts
Close the partnership’s bank accounts and open new ones under your name, or under a Doing Business As name tied to your SSN or new EIN. Leaving the old accounts open invites commingling and makes Schedule C bookkeeping harder than it should be. Update vendor accounts and credit lines with the new name and tax ID so that year-end Form 1099 reporting is accurate.
Licenses and Permits
Most business licenses and permits are issued to a specific entity and don’t transfer. Cancel the partnership’s licenses and apply for replacements under the sole proprietorship. Sales tax certificates, occupational permits, and professional licenses all need to be reissued. Operating without valid permits during the transition, even briefly, can draw fines.
Payroll
If the partnership had employees, both the old partnership and the new sole proprietorship file Form 941 for the quarter of the transfer, each reporting only the wages it actually paid. Attach a statement to the partnership’s final Form 941 identifying the new owner, the type of change, the date, and who is keeping payroll records.11Internal Revenue Service. Instructions for Form 941
As a successor employer, you may count wages the partnership already paid to continuing employees when applying the Social Security wage base and the $7,000 FUTA wage base for the year, which avoids taxing the same wages twice.12Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide Collect new W-4 forms from transferred employees.
How Your Taxes Change Going Forward
Once the sole proprietorship starts, business income and expenses land on Schedule C rather than flowing through a K-1.13Internal Revenue Service. Instructions for Schedule C (Form 1040) Net profit from Schedule C feeds Schedule SE, where you calculate self-employment tax.14Internal Revenue Service. About Schedule SE (Form 1040), Self-Employment Tax
Self-employment tax is 15.3%: 12.4% for Social Security and 2.9% for Medicare. For 2026, the Social Security portion applies to the first $184,500 of combined wages and net self-employment earnings.15Social Security Administration. Contribution and Benefit Base The Medicare portion has no cap. Above $200,000 in self-employment income ($250,000 if married filing jointly), an additional 0.9% Medicare tax applies to the excess.16Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
You can deduct half of your self-employment tax when calculating adjusted gross income. The deduction goes on Schedule 1 of Form 1040 and reduces your income tax, though not the self-employment tax itself.17Internal Revenue Service. 18Internal Revenue Service. Estimated Taxes The transition year is the trickiest one to estimate, because you’ll have partnership K-1 income for part of the year and Schedule C income for the rest.
Keep the Records
You keep all partnership records and dissolution documents after the conversion. The IRS generally requires retaining tax records for at least three years from the date you filed the return, six years if more than 25% of gross income went unreported, and indefinitely if no return was filed. Employment tax records must be kept at least four years after the tax was due or paid.19Internal Revenue Service. How Long Should I Keep Records?
For transferred assets, keep basis records until at least three years after you file the return for the year you sell or dispose of the property. That may be decades away for real estate or long-lived equipment, so the practical move is to archive the dissolution agreement, final Form 1065, all K-1s, the purchase agreement, both Forms 8594, valuation reports, and bills of sale permanently. Rebuilding basis information years later is expensive when it’s possible and impossible more often than owners expect.19Internal Revenue Service. How Long Should I Keep Records?