buying partner pays taxes on his gain, measured 50% from initial price and 50% from purchase price for 50%.
Seller pays tax on his gain of his 50% when you buy him out, your get deferred until you sell eventually.
Example:
bought for 200K, 150K mortgage. each 50% was worth 25K in 2003.
Now mortgage is 120K and it is worth 250K. Equity gain: 80K
you buy his 50% for 65K (25K plus 40Kgain). seller's gain is 40K and he pays taxes on it.
you will pay taxes on any gain above your accrued 40K gain when you eventually sell.
2nd option: you pay him not 65K, but agree on 50K. His gain is only 25K now .. and your accrued gain is 55K.