Reference no: EM132701123

Question - Blythe and Ella acquired a 5-acre tract of land on 8th Avenue South in the Melrose area of Nashville for $1,000,000 in 2010, as tenants in common. Each of Blythe and Ella contributed $100,000 to the down payment and they financed the remaining $800,000 of the purchase price with a 10-year, interest-only loan at 5% interest from a local credit union. The loan was secured by the 5-acre lot and any current and future structures attached thereto. Blythe and Ella were jointly and severally liable for the loan (i.e., recourse to each) and they had not entered into any separate contribution or sharing agreements between them with respect to this loan.

The only structure on the lot was a dilapidated building that had been used by a car dealership several years ago. Although Blythe and Ella knew they could not rent the building given its current state of disrepair, they planned to install a self-pay parking terminal and charge $2/hour with a maximum of $20 for 24 hours to park in the lot that had been used by the dealership for its inventory.

Initially, the plan was to generate enough parking revenue to cover the cash expenses- interest on the loan, property taxes, insurance, electric bills to power the lights in the parking lot-and then sell the lot to a developer whenever "they felt the time was right". Blythe and Ella agreed to share all profits and losses, including any gain or loss on the sale of the land, equally.

The revenue from the parking lot was deposited into a joint checking account at the credit union that financed the purchase. Although both Blythe and Ella had signature and check-writing authority on the account, they agreed that Ella, who was a CPA, would maintain the check register and reconcile the monthly bank statements. Between the two of them, but not documented formally in any sort of agreement, Blythe told Ella that she did not need to get her consent whenever she needed to make a payment of less than $1,000. For amounts equal to or in excess of $1,000, both Blythe and Ella had to agree on whether to make the expenditure; if they could not reach an agreement, the expenditure would not be undertaken.

Assume that instead of holding the tract as tenants in common, Blythe and Ella contributed the property to Melrose Place, LLC, a newly formed Tennessee limited liability company, in 2010 shortly after they purchased it. Each of Blythe and Ella held a 50% membership interest. Melrose Place, LLC has not made any tax elections.

In connection with this contribution, Melrose Place, LLC assumed the loan encumbering the contributed property and the lender fully released Blythe and Ella from any and all recourse relating thereto. The Assumption and Release Agreement entered into with the lender expressly stated that the lender's only recourse with respect to the nonpayment of any amounts due and owing under the Loan Agreement was to foreclose upon the lot now held by Melrose Place, LLC or accept a deed in lieu of foreclosure. Put another way, the lender could not seek recovery from Blythe, Ella, or Melrose Place, LLC if the creditor foreclosed upon that certain lot securing the loan and the value of such lot at the time of foreclosure was insufficient to cover the amount owed on the loan.

(a) Please prepare the opening book and tax balance sheet for Melrose Place, LLC. Assume that all the $1,000,000 purchase price was allocable to land.

(b) Please explain whether the debt assumed by Melrose Place, LLC should be classified as recourse or nonrecourse for purposes of Section 752 of the Internal Revenue Code of 1986, as amended. Please explain how to calculate the amount of debt allocable to Blythe and Ella that should be reported on their respective Schedule K-1s?

(c) What are the tax consequences of forming the LLC and contributing the property to it? Your answer should address (i) gain or loss recognition, if any, by each party to this transaction and the character thereof, (ii) inside and outside basis, (iii) book capital account balances and (iv) holding periods.

(d) Would your classification of the debt assumed by Melrose Place, LLC change if the Assumption and Release Agreement provided that the lender could foreclose upon any assets of the LLC? Please explain your analysis.