Reference no: EM132717861

Partnership Tax Outline

Tax Classification of Business Enterprises

Problem 1
A contributes $50K cash, B contributes land with a basis of $40K and a FMV of $50K, and C contributes securities with a basis and FMV of $50K. Basis and book value may start off the same and change because of different depreciation methods for accounting and tax purposes. Beginning balance sheet:

Assets			Liabilities
	Adjusted Basis	Book Value			Adjusted Basis	Book Value
Cash	$50K	$50K	Debt		None
Land	$40K	$50K	Equity (partners' capital)	A	$50K	$50K
Securities	$50K	$50K		B	$40K	$50K
				C	$50K	$50K
Total	$140K	$150K			$140K	$150K

(a) Leasing land for $15K and selling securities. Cash increases by $65K. $15K is split equally between the partners (because they agreed to sell all equally). Rent income passes through to all partners equally. Under 705, basis of partnership interest increases by the amount of tax paid (each partner pays tax on $5K and their basis are increased by that amount).
(b) Partnership borrows $300K and then buys more land for $330K. No tax consequences. New liability of $300K. New asset of $330K. Additional $30K comes from cash, so cash goes down to $85K. Partners basis each increased by $100K because of the increase in partnership liabilities; DOES NOT increase book value - can take losses for more than they contributed.
• § 752 Treatment of certain liabilities. Partners' outside basis is increased when the partnership obtained a loan (or other liabilities).
a. Biggest difference between partnerships and S corporations.
b. Do not use an S corporation if it will be highly leveraged.
c. Pretend like they take out a loan personally and contribute the cash.
• § 704(d) cannot take a loss in excess of adjusted basis. This is typically not a problem with help from 752. This makes sure that partners get the benefit of the Crane rule and gets their pass through losses.
a. For example, if you take a loan and then lose it all, you would not get to take those deductions without 752.
(c) Partnership distributes $20K to each partner. Cash decreases by $60K. Partners not taxed on distribution because they can use their large amount of basis. § 731. Basis is decreased by amount of distribution. § 733. So basis and book value both reduced by $20K for each partner.
(d) Partnership sells Parcel #1 for $65K. Parcel #1 had a basis of $40K and FMV $50K. Now sold for $65K (book value of assets have been undervalued for some time). B contributed it with $10K gain. Partnership is recognizing $25K gain. $10K taxed to B, the leftover $15K is split amongst the partners. Cash goes up, basis increased by amount passed through, and book value increased by $5K for each partner.
• § 704(c) gain/loss passes through to partner that contributed.
(e) Parcel #2 now has a FMV $420K, the assets and capital accounts are restated to current value, and new partner D contributes $70K to the partnership in exchange for a 25% general partnership interest. So increase book value of property to $420K, which would increase the partner's book value capital accounts.
• § 752. New partner gets some basis because she has a share in partnership liabilities equal to the amount she put in.
a. (b) The other partners get a decrease in basis b/c they all have a decrease in liability. Treated as a non-taxable distribution. Look to section 731 and 733.
b. § 704(c). The gain on parcel #2 passes to A, B, and C but not D, because the property appreciated before he got there.
Treatment of Liabilities
Impact on Partner's Outside Basis
Page 28 Problems
A, B, C, and D each contribute $25K to the ABCD partnership, which then acquires a $1 million building, paying $100K cash and borrowing $900K on a nonrecourse basis.
a. If the parties are equal general partners, what is each partner's outside basis? - nonrecourse debt allocated equally to each of their bases. $225K added to each of their $25K basis.
b. What result if the partnership is a limited partnership, A is the sole general partner and all the partners share profits and losses equally? - nothing changes because the debt is named nonrecourse. None of the partners are liable.
c. What result in (b) if the partnership were personally liable for the debt? - partner with most economic risk of loss gets the most basis.
§ 752 Treatment of certain liabilities
(a) Treats any increase in a partner's share of partnership liabilities as if it were a cash contribution by the partner to the partnership, increasing the partner's outside basis under § 722.
(b) Treats any decrease in a partner's share of liabilities (partnership assumption of a partner's liability) as if it were a cash distribution to the partner, decreasing his outside basis under §§ 705, and 733.
(c) A liability to which property is subject shall be treated as a liability of the owner to the extent of the FMV.
• Consistent with the Crane rule that a partner's outside basis includes his share of a partnership's liabilities (same as basis in house includes mortgage).
• Regs. § 1.752-1
1. (a)(1). A partnership liability is a recourse liability to the extent that any partner bears the economic risk of loss for the liability. Test is stated in 1.752-2.
2. (a)(2). But if no partner bears the economic risk of loss, the liability is classified as nonrecourse. For example, partners of an LLC bear no risk on debts of the company.
3. (a)(4). Liabilities that are deductible, such as accounts payable, are disregarded.
• Regs. § 1.752-2
1. (a). A partner's share of recourse liabilities equals the portion of the liability for which the partner bears the economic risk of loss.
2. (b). To determine a partner's economic risk of loss, ask who would be obligated to pay the liability if all the partnership's liabilities are payable in full and all of the assets, including cash, are worthless. Assume the worst case scenario.
i. To determine economic risk of loss, follow the worst case scenario and see what partner owes what [-2(b)(1)]. This typically leads to general partners having to share the loss while limited partners' loss is limited to the amount contributed.
3. Partner with most liability gets the most basis.
• Regs. § 1.752-3(a). Nonrecourse debts are generally allocated among the partners in accordance with each partner's share of partnership profits rather than losses b/c none of them have liability. (also includes minimum gain and gain that would be allocated for partnership property subject to nonrecourse liabilities.)

Problem 2

(1) A and B contribute $30,000 each, C contributes land with FMV $60,000 subject to recourse debt of $30,000. All general partners with equal interest in profits and losses.
a) Tax consequences if land basis is $40,000? - A and B basis increases by $10K each, so their basis is $40K each. C's basis decreases by $20K and becomes $20K (because he is liable for 1/3 but is also walking away from 2/3 - so 40+10-30). The partnership's basis is $40K. Regs. § 1.752-2(a).
b) Tax consequences if land basis is $10K? - A and B's basis becomes $40K each. C's basis is 0 (10+10-30). And C recognizes a gain of $10K ($30K distribution - $20K basis). § 731. C pays tax on $10K and his basis is still zero and the partnership's basis becomes $10K.
c) Tax consequences if land basis is $40K and nonrecourse, partners agree to 1/3 profit sharing? - analysis includes 3 parts (minimum gain, taxable gain from 704(c), and relating to share of profits). Under 704(c), C contributed this property, ask whether there would be any gain if the partnership just walked away from the debt - in this case no - $30K - $40K. Regs. § 1.752-3(a). So same result as problem (a).
1. In some situations, there may be a gain if selling the property back to the bank (value of mortgage - basis).
d) Tax consequences if same as (b) but nonrecourse? - if the partnership walked away from the debt, there would be a gain of $30K - $10K = $20K. All $20K would be taxed to C. So his basis is increased by $20K first before doing anything else. The other $10K of basis is split between all three of them to equal $23,333 for C. C's basis = $10K + 23,333 - 30K (decreased liabilities) = $3333. Partnership basis = $10K
(2) A joins B, C, and D and everyone has a ¼ interest. A contributes an account receivable with 0 basis and $20K face value. The partnership also assumes $6K of A's accounts payable. What are the tax consequences? - nothing happens.
• Receivables: $0 Basis; $20K FMV. When the partnership collects the receivable, it will pass through to him later on. So basis does not change now.
• Accounts Payable (assume recourse): $6K - the kind of liability that if he paid it he could deduct it, so maybe shouldn't be penalized. Therefore, these types of debts are not included in liabilities and does not affect the contributing partner's basis or the other partners. Regs. § 1.752-1(a)(4). However, if on the accrual method of accounting (very rare), it would be a liability.

Problem 3
C gets capital interest whose sole asset is a commercial building with FMV $150K and adjusted basis $90K, which has been depreciated on the straight line method. A & B have $45K outside bases in their interests. C has performed real estate management services for the partnership over the past year and has agreed to perform additional services in the future. FIRM basis $90K; FIRM FMV $150K.
(a) Tax consequences to C and the partnership (A&B) if in year one C receives a 1/10 capital interest in the partnership as compensation for his management services over the past year? - NO BIG TAX AFFECT OVERALL, BUT INCREASE IN ASSET BASIS.
• Transfer of 1/10 interest in the land to C who then contributes back to the partnership. 1/10 of $150K is $15K. § 83(a) comes in (assuming totally vested and not subject to forfeiture). Ordinary income = FMV of interest received - amount paid for interest. Treated as independent K income. Amount paid as tax becomes C's basis and then amount of interest.
• The partnership also has a taxable event (as in existence before the new partner joins, so it is passed through to A & B). This triggers gain, but not all $60K of the gain (just 1/10th of it). $6K realized ($15K amt. realized - $9K adj. basis = $6K). A & B both pay for $3K of gain, basis is increased by amount taxed.
• Partnership also gets a deduction for whatever C puts down as income, when he puts it down as income [§ 83(h)]. This deduction more than offsets the gain. Deduction can only be made immediately if an ordinary and necessary business expense. Basis goes down for deduction.
• Then pretend the interest is transferred back, 721, 722, and 723 steps up the basis of the asset ($96K ? increased by the $6K of gain).
• Proposed Reg. § 1.83-3(e) & Proposed Reg. § 1.721-1(b): not much support, but these would get rid of the gain element of this transaction. C would still be taxed and A&B would get their deduction, but would eliminate the fake asset transfer to and back.

(b) What result in (a), if C receives his capital interest in exchange for legal services performed in connection with the acquisition of the building (essentially asking what would happen if the services provided are capital)? - The firm cannot take an immediate deduction, must depreciate over time.
(c) What result in (a), if C receives his interest as compensation for services to be rendered in the succeeding three years provided, however, that if C ceases to render services before the end of year three, C or any transferee of C must relinquish his interest in the partnership. Assume for this problem that the building will have a value of $450K and an adjusted basis of $90K at the end of year three. - If C elects under § 83(b) to be taxed in the current year, the results would be the same. If C did not elect, the same analysis but his gain would be $45K instead of $15K.

Problem 4

1. AB partnership is a law firm. Associate C is offered a 1/3 partnership interest in the future profits. C is not required to make any capital contribution. Is C taxable upon admission to the partnership? - NO
a. Can cause problems where people buy partner interests in private equity firms, which make mostly capital gains. So a taxpayer can avoid ordinary income and gain capital gains.
2. Experienced real estate manager C receives a non-forfeitable 1/10 profits interest in the AB general partnership, whose sole asset is a commercial building (FMV $1 mill) in return for his agreement to render management services in his capacity as a partner. Net rentals from the building recently have been averaging $100K per year. C has been asked to manage the building in the hope his expertise will increase the rental income and lead to a profitable sale of the property.
a. What are the tax consequences to C upon receipt of the profits interest? - Maybe taxed if there is a "substantially certain and predictable stream of income from partnership assets" such as rental income. BUT probably doesn't include "average" rental income, which indicates it may fluctuate. Depends on how reliable this income stream is.
b. What are C's tax consequences upon receipt of the interest if, prior to becoming a partner, rendered services to the partnership in connection with obtaining financing and soliciting tenants for the building? - No tax consequences for past services rendered. Rev. Pro. 93-27.
c. What result in (a) if C sells his profits interest for $50K within one year and prior to receiving profits? - taxed
d. What results in (c) to the partnership (and to A & B)? - Partnership takes a deduction and other partners are taxed.
e. What result to C and to the partnership in (a) if C's profits interest was subject to forfeiture until C rendered services for the partnership for a period of five years? - No § 83(b) election needed, not taxed until vested.

Problem 5

LP organized in Dec. to construct and operate a luxury hotel. Developer will be the general partner and contribute $100 cash for his interest. LP interests of $100K each have been sold by Broker to twenty investors, each of whom has been furnished with a voluminous prospectus describing the offering. All the investors are clients of Financial Planner, an affiliate of Broker, who acts as an investment advisor to wealthy individuals.
To what extent are the following expenses, all of which are to be paid in the current year out of the $1 mill contributed by the limited partners, property classified as "organizational expenses" under Section 709(b)(3)?
a) A $100K "placement fee" paid to Broker for his efforts in selling the LP interests? - NOT OE b/c not currently deductible or amortizable, a "syndication expense."
b) A $50K "organizational fee" paid to Developer for his services in connection with the organization of the partnership and negotiating the terms of the P agreement? - YES OE b/c "organizational expense includes feeds for services incident to the organization of the partnership, such as negotiation and preparation of a partnership agreement."
c) $40K paid to attorney for drafting P agreement, filing the necessary papers and preparing the offering documents? - Depends, drafting partnership agreement and filing papers for partnership formation are organizational expenses, but registration fees for securities and legal fees of an underwriting, placement agent or issue or for advice for offering documents are syndication expenses that must be capitalized.
d) $10K paid to Accountant for preparing the financial projections included in the offering documents? - NOT OE b/c accounting fees for preparation of representations to be included in offering materials are syndication expenses and must be capitalized.
e) $10K paid to Printer for printing the LP offering prospectus? - NOT OE b/c printing an offering prospectus is an amount paid to promote the sale of partnership interests and is a nondeductible syndication expense. This type of expense is not amortizable.
f) $20K paid to Tax Attorney for tax advice to the prospective investors and for preparation of a tax opinion letter concerning issues affecting the partnership? - Depends.
g) $40K as an initial fee to Financial Planner for matters related to more than just setting up the partnership? - Depends.

Partnership computations [probably an unnecessary provision]
• (a) Requires a partnership to determine its own taxable income and provides rules designed to preserve the character of capital gains, charitable contributions, foreign taxes and other items that may be subject to special treatment in the hands of the partners.
a. Treat the partnership like an individual, not a corporation or trust. But certain deductions not allowed and must separately state things in 702(a)
b. Deductions excluded:
i. Personal exemption
ii. SALT taxes
iii. Charitable contributions - to preserve the FMV deduction to the partners (benefit to donate appreciated property b/c you get to take a deduction equal to the FMV). This provision is here to ensure the partner's basis is not reduced too much (only reduced by the basis of the property contributed).
iv. Net operating loss deductions - this just doesn't happen at the partnership level.
• (b) The partnership will select its accounting method and make various elections for the partners. And the partnership will have its own taxable year, which may be separate from the partners. EXCEPT for:
a. Discharge of indebtedness, and
b. Deduction and recapture of certain mining exploration expenditures.

(a) How and when will AB, A & B report the income and who will be liable for the taxes? [702(a)]
• Short-term gain/loss stated separately
• Long-term gain/loss stated separately
• 1231 gain/loss stated separately (capital gain/loss when selling capital assets for more than you purchased them for)
• Charitable contributions stated separately
• Dividends stated separately
• 1231 casualty gain/loss stated separately
• Interest on margin account [investment interest] - interest paid when borrowing money to make investments are allowed as a deduction only to the extent of income from investments (excluding capital gain income) [Reg. § 1.702-1(a)(8)(ii)]
• The rest is lumped together, except for tax-exempt interest.
(b) Assume this is the first year of partnership operations, A's basis in his partnership interest is $70K and B's basis in her partnership interest is $40K. What will be the tax consequences of AB's first year of operations to A and B?
• Income to both in the amount of $29,600 passed through. Outside basis goes up by that amount (amount lumped together, separating doesn't matter). A's basis is now $99,600; B's basis is now $69,600. And then increased by tax-exempt income. So basis increases by $250 for each.
(c) What would be the result in (b) if the partnership distributed $20K in cash to each partner at the end of the year?
• No income, unless money received exceeds outside basis. But basis goes down. §§ 731, 732, 733.
(d) Would it matter if the § 1231 gain on the sale of the machine would have been ordinary income if A had sold it individually?

Problem 6

C & D are partners who share income and losses equally. C has an outside basis of $5K in his partnership interest and D has an outside basis of $15K in her partnership interest.
(a) During the current year the partnership has gross income of $40K and expenses of $60K. What are the tax results to C and D?
• Both have $10K share in loss. D's basis will be $5K. C will have excess that will have to be carried over.
(b) What are the results to C & D in the succeeding year when the partnership has $20K of net profits?
• D's basis will become $15K. C can use some of his loss carryover and his basis will be $5K and he will only be taxed on that amount.
(c) How might C have alleviated his problem in the first year?
• Contribute money to increase his basis or have the partnership borrow money to do so.
(d) What result in (a) if the net $20K loss consists of $15K of ordinary loss and $5K of long-term capital loss?
• The extent of C's loss can be $5k so multiply that by (7.5/10) to determine the amount of ordinary loss (3.75K) AND 1.25K capital loss. C's carryover loss will be 3.75K ordinary loss (7.5-3.75) and 1.25K capital loss (2.5-1.25).
(e) What result to S, C's son, in (a) if C gives his interest in the partnership to S on the first day of a year in which the partnership has profits of $20K?
• Probably cannot give the carryover to his son. Lifetime gift donees generally cannot take your losses [§1015].

Problem 7

Passive Loss Limitations
§ 469 Passive activity losses and credits limited: These rules are applied at the partner level, not partnership. And they are only applied after the 704(d) and 465 limitations. Breaks life into 3 categories: active businesses (employment), passive activities (rental, etc.), and portfolio (stock market, etc.).
• (a) Deductions and credits from passive activities can only be taken to the extent of income from passive activities.
• (b) Excess losses can be carried forward to future years.
• (c) Passive activity means any activity (A) which involves the conduct of any trade or business, and (B) in which the taxpayer does not materially participate.
1. (2) Includes any rental activity.
a. (c)(7) Rental activity exception for taxpayers in the real property business.
b. (i) Rental activity exception for "mom and pop" rentals - they can take a deduction of $25K. AGI cannot exceed $100K, phase out.
2. (3) Passivity activity does not include a working interest in any oil or gas well which the taxpayer holder directly or through an entity that doesn't limit the taxpayer's liability with respect to the drilling or operation. Only applies to general partners.
• (g) Disallowed losses from a particular activity (but not credits) may be deducted in full on a taxable disposition of the entire activity.

• (h) A taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial.
1. (2) Limited partners are per se passive (includes non-managing LLC members). Regulations provide exceptions for active LPs and LLC members.

Problem 8

(1) Producer owns a 40% GP interest and 20% LP interest in PG-14 Associates, a motion picture production partnership which also pays Producer a $100K annual salary for her services as a full-time (1500 hours per year) producer. After deducting Producer's salary, the partnership has a $300K net loss in the current year. Producer's aggregate outside basis for her partnership interests at the beginning of the year is $350K. Producer's outside basis is attributable to cash contributed to PG-13 Associates.
a. What are the tax consequences to P for her interests for the current year?
b. What result in (a) if P spends most of her time farming and only devotes 300 hours during the year to PG-13?
c. What result in (b) if P had devoted 1500 hours to PG-13 during each of the previous 5 years?
d. What result in (b) if the partnership's loss for the year is only $200K b/c it also realizes $60K of dividend income and $40K of net gains from sales of marketable securities?
e. What result in (b) if P also has $75K of income from an interest in a "burned out" real estate LP interest?
f. What result in (b) if P also has a $25K loss from a rental real estate LP interest?
g. What result in (b) if P also has a $50K loss from an investment in a GP that owns a working interest in an oil and gas property?
h. Same as (g) except P holds her interest in the oil and gas partnership as a LP?
(2) During the current year LP has investments in four limited partnerships as follows:
a. Motion picture productions limited partnership in which LP has an outside basis of $10K attributable to LP's cash contribution to the partnership. LP's distributive share of loss in this partnership for the current year is $25K.
b. An equipment leasing limited partnership in which LP has a $100K outside basis attributable to a $15K cash contribution and an $85K nonrecourse liability. LP's share of loss for the year is $200K.
c. A real estate limited partnership in which LP has a positive outside basis and his share of partnership income is $30K for the year.
d. A R&D limited partnership in which LP has an outside basis of $60K attributable to his $60K cash contribution to the partnership. LP's share of the partnership's loss for the year is $40K.
(3) Consider to what extent LP may deduct his share of losses from these partnerships for the current year, assuming he has no carryovers under sections 704(d), 465, or 469.

Problem 9
(1) A and B each contribute $100K upon formation of a limited partnership. A is a general partner and B is a limited partner. The partnership purchases an office building on leased land for $200K and elects straight-line cost recovery. Assume that the property has a 10-year recovery period. The partnership agreement allocated all items of income and loss equally with the exception of the cost recovery deductions, which are allocated entirely to B. Assume that both partners are unconditionally obligated to restore a deficit to their capital accounts upon a liquidation of the partnership.
a) Assume that apart from cost recovery deductions, the partnership's rental income is equal to its operating expenses. What must the partners' respective capital account balances be at the end of year one if the allocation of cost recovery deductions is to have economic effect?
1. The partnership only has a $20K net operating loss deduction for the year. Basis and BV of property is decreased by $20K. B's basis and BV must decrease by $20K. So all depreciation deduction to B, keep capital accounts per regulations, and honor capital accounts.
b) Assume the partnership sells the building on Jan. 1 of year two and immediately liquidates. Again, with an eye toward qualifying the allocation, how must the proceeds be distributed if the building is sold for $180K? For $200K?
1. If sold for $180K, B must get $80K and A must get $100K. Distributed in accordance with their capital accounts. If depreciation does not turn out to be real, most partnership agreements include "chargeback" provisions stating the person who takes the deduction gets all the gain if there is any. If sold for $200K, B gets $80K, A gets $100K and then B must pay tax on the extra $20K.
c) Assume the agreement further provides that gain on disposition will be allocated to B to the extent of the cost recovery deductions specially allocated to her. What result when the partnership sells the building on Jan. 1 of year two for $200K?
1. This is talking about the "chargeback" provision. Without this, they would split the $20K.
d) Assume that B is not required to restore a deficit in her capital account, but the partnership agreement includes a "qualified income offset." If the partnership continues to operate the building, what is the result to A and B in year one? In year six?
1. In year one, B would not have a deficit but in year six he would. Without the qualified income offset or promise to restore, his account would be negative but he would have no requirement to restore it so he does not feel the economic impact. However, if your allocations never make the capital account negative, #3 of the big three is not really needed. So (1) and (2) can be used alone with a qualified income offset as long as the capital account never goes negative (start allocating the depreciation deductions to the other partner in year six). Once it goes negative, he will be taxed on distributions.
e) What results in both years under the facts in (d), if in addition B has contributed her promissory note for $100K to the partnership?
1. Economic Effect Equivalence test [(b)(2)(ii)(i)]. Can do this.
f) What results under (e) if in year six the building has a $400K FMV and A & B acting as partners, agree that they will borrow $200K on a recourse basis, using the building as security, and distribute the proceeds equally to themselves early in year seven?
g) What result in (e) if in year six the value of the building is $300K and A and B acting as partners agree that when its value reaches $400K they will take out a $200K recourse mortgage and distribute the proceeds equally?
h) Assume that B is not required to restore a deficit in her capital account and that the partnership agreement does not contain a "qualified income offset." IF the partnership continues to operate the building, what is the result to A and B in year one? In year six?
i) What results in both years under (h) if in addition B has contributed her promissory note for $100K to the partnership?
(2) C & D are equal partners in a general partnership formed to design and produce clothing for sale to retailers located throughout Europe and the United States. D is a nonresident alien. At the beginning of the tax year, the relative dollar amounts of United States and foreign source income cannot be predicted. Any foreign source income allocated to D is exempt from United States taxation. Assume that all of the following allocations have economic effect.
a) What result if the partnership agreement provides that all U.S. source income will be allocated to C, and all foreign source income will be allocated to D?
a. Not a shifting allocation b/c the capital accounts are substantially affected.
b) What result if the agreement provides that all income will be shared equally but that D will be allocated all the foreign source income up to the dollar amount of her 50% share of income?
a. This is a shifting allocation b/c there is no substantial economic effect. The capital accounts will be the same but they are reducing tax liability.
c) Assume, instead, that at the beginning of the tax year it can be predicted that the relative dollar amounts of U.S. and foreign source income will be roughly equal. What result if the agreement provides, as in (a), that all U.S. source income will be allocated to C and foreign source income to D?
a. Transitory allocation.
(3) E & F form a limited partnership to purchase and lease a computer for $1 million. E, the limited partner, contributes $990,000 and F, the general partner, contributes $10K. The agreement provides that section 168 cost recovery deductions will be allocated entirely to E and that all other items of income or loss will be allocated 99% to E until he has been allocated income equal to his share of cost recovery deductions and partnership losses. Thereafter, E & F will share income and loss equally. Assuming the capital account, liquidating distribution, and deficit restoration tests are met, will the allocations be respected? See Reg. 1.704-1(b)(5) examples (2) and (3).

Problem 10
G&L form limited partnership. G contributes $80K, L contributes $320K. The partnership borrows $1.6 million to buy a building worth $2 million. The loan is depreciable. Depreciation is $200K/year. Partnership agreement gives 20% to G, 80% to L until the partnership breaks even (no more start up loss) and then it will be 50/50. Only G is required to restore capital account and there is an income offset for L and minimum gain chargeback provision. Rights to distributions will be 20/80 until break even, then it will be 50/50.
a) Assume that rental income from the property of $150K equals operating expenses (including interest on the nonrecourse debt) of $150K. Determine the allocation of the partnership's cost recovery deductions in each of the first three years of operations and determine the partners' capital accounts at the end of each year.
a. Partners now have tons of basis (G: $400K, L: $1.6 mill). Depreciation of $200K in the first year allocated 20/80 (G: $40K loss; L: $160K loss). Basis down (G: $360K, L: $14.4 mill) and capital account down (G: $40K, L: $160K). Year two depreciation of $200K, but capital accounts are now at zero. The basis of the building is now equal to the amount of the loan. In year three the capital accounts would be negative and the basis of the property is less than the loan. In year three, still allocate the $200K depreciation 20/80 and both accounts are allowed to go negative.
b) Same as (a), except the partnership agreement provides that L will be allocated 99% and G 1% of all the partnership's cost recovery deductions.
a. Everything else is 80/20, except this 99/1. However, there is no significant partnership item being allocated 99/1 also as required by (e). Still under Reg. § 1.704-1 until there is actually minimum gain (property's new basis is less than amount of debt). Even though one partner's capital account is negative in year two, the lenders money is not being lost yet. So still in -1 until year 3. And since there is only a qualified income offset, L cannot take his capital account negative. In -2 in year 3 and its fine as long as the 99/1 is ok and the minimum gain is also allocated that way.
c) Same as (a), except that the partnership agreement provides that L will be allocated 70% and G 30% of all the partnership nonrecourse deductions.
d) Is there an allocation under the minimum gain chargeback in (a) if at the end of year four G contributes $80K and L contributes $320K to the partnership, which uses the funds to pay down $400K of the liability.
e) Is there an allocation under the minimum gain chargeback in (a) if during year four the partnership converts $600K of the $1.6 million nonrecourse liability to a recourse liability? Determine the partners' capital accounts at the end of years four and five.
f) What results in (a) in year four if in that year, when the property has depreciated in value, the partnership incurs an additional $300K of nonrecourse liability and it distributes the proceeds $60K to G and $240K to L?

Problem 11
(1) A, B & C form an equal partnership. A contributes accounts receivable for services rendered (AB - $0, FMV - $10K; B, a real estate dealer, contributes lots held primarily for sale (AB - $5K, FMV - $10K); and C, and investor, contributes land (AB - $20K, FMV $10K). Unless otherwise stated, the partnership is not a dealer in receivables or land, all contributes assets have been held long-term by the partners prior to contribution, and the traditional method of allocation is applied with respect to all contributed property. What tax results in the following alternative transactions:
Capital account = FMV of property contributed.
a) The partnership sells the receivables contributes by A for $10K?
1. Same result as if just collected the receivables. All $10K is passed thru to A. § 724 - the gain is ordinary because it would have been ordinary for A. A's basis goes up to $10K.
b) The partnership sells the lots contributed by B for $10,600?
1. B would be taxed on $5200 and his basis would go up to $10,200. A and C would both get $200 of gain they have to pay tax on. The additional $600 is covered by 604(b) and here everything is shared equally. § 724 - B is a dealer so ALL the gain is ordinary income.
c) The partnership sells the lots contributed by B for $9,100?
1. 1.704-3(b). $4100 tax gain, but $900 economic loss. Using the traditional method, B is taxed on the $4100 gain and that is it. The book value loss is shared equally, but there is no tax loss. B's basis would increase $4100, but his (and A&C's capital accounts all decrease by $300).
d) Same as (c) except the partnership elects to use the remedial method of allocation.
1. 1.704-3(d). A & C each get $300 loss, but B is taxed on that $600. B also gets a $300 loss. A's basis and capital account is now $9700. B's is the same. C's basis is $19700 and his capital account is $9700.
e) The partnership is a real estate dealer and sells the land contributed by C for $17K?
f) Same as (e) except the sale is for $7K?
g) Would the result in any of the above transactions change if all sales had occurred six years after the property was contributed?
(2) A contributes $100K cash to the AB partnership and B contributes a building with an adjusted basis of $50K and a FMV of $100K. Unless otherwise stated, apply the traditional method with respect to all contributed property.
a) If the building is depreciable, has a ten-year remaining recovery period and is depreciated under the straight-line method, how much tax and book depreciation will be allocated to each partner?
a. Depreciation is based on property's basis (so $5K per year). $5K is given to A per year. Make sure non-contributing partner has tax equal to book.
b. 1.704-1(b)(2)(iv)(g)(3) [page 1329]. $10K reduction in book value. Use same method - take 1/10 for deductions, take 1/10 for book value. 1/10th of 100 is 10. A's basis is reduced by $5000, B gets no depreciation deduction and his basis stays the same. A & B's BV are each reduced by $5K.
c. 1.704-3(b). States that non-contributing partner's depreciation deductions should be equal to book value decreases.
b) Same as (a) except that B's basis in the building is $60K?
a. $6K basis depreciation each year. $10K of book depreciation each year. Split book value so then the first $5K goes to A, the other $1K goes to B.
c) Same as (a) except that B's basis in the building is $40K?
a. $4K basis depreciation each year. $10K of book depreciation each year. A would just not get enough deductions to keep his basis equal to his book value under the traditional method. However, this can be fixed with the curative allocations (future depreciation deductions allocated to A). 1.704-3(c).
b. 1.704-3(d)(2). Or you can use the remedial method. BV has to be decreased with two different proportions. $40K is based on 10 years ($4K/year). $60K is based on 20 years ($3K/year). Each partner's BV decreases by $3.5K. This is done for 10 years and A gets $3.5K of depreciation a year and B gets $500. After 10 years, the buildings basis will be $0 but there will still be $30K BV. At that point, there is no more tax depreciation so A is given the BV depreciation and B will pay the tax (like a curative allocation).
d) Same as (a) except that B's basis in the building is $120K?
a. $12K basis depreciation each year. $10K of book depreciation each year. A's basis and bv is reduced by $5K. B gets the extra $7K basis depreciation.
e) If in (a) the building is sold for $90K after it has been held (and depreciated) by the partnership for 2 years, how must the partnership allocate the tax gain on the sale?
f) Same as (e) except the building is sold for $60K?
g) What result in (c) if the recovery period for the building is 20 years and the partnership elects the remedial method of allocation?
(3) A and B, both dealers in real estate, find a parcel of land to purchase for $100K as an investment. They believe it can be sold in two years for $200K. They either will buy the land as tenants-in-common for $100K and jointly contribute it to a partnership or contribute $50K each to an equal partnership, which then will buy the land.

Problem 12
(1) A, B & C each contribute $20K to form the ABC general partnership. The partnership agreement satisfied the primary test for economic effect under 704(b). Partnership profits and losses are allocated 40% to A, 40% to B, and 20% to C. The partnership uses its $60K cash and borrows an additional $40K on a recourse basis and purchases land for $100K.
a) How will the $40K liability be allocated and what will be each partner's outside basis?
1. 1.752-2(b)(i)-(v). Doomsday scenario is used to determine who is at risk. Apply what the partners would owe each other (this would include the big three).
i. Partnership assets are all worthless, and sold for zero consideration (property sold for $0, loss of $100)
ii. Pass through the loss using 704 (A & B are allocated a loss of $40K each, and C is allocated a loss of $20K; basis of bank debt - $40K - is allocated equally between A&B because they agreed to suffer more of the loss and their capital account balances are both negative by $20K).
iii. Partnership liquidates
iv. Lender enforces all rights against partnership and partners
v. Partners enforce all rights against each other (all have money)
b) What result in (a) if A, B, and C has contributed $10K, $20K, and $30K to the ABC partnership?
1. Capital account balances are: A (-$30K); B (-$20K); C ($10K). Basis is allocated $50K to A&B, but $10K goes to C - 3/5 of bank debt goes to A and 2/5 goes to B.
c) What result in (a) if A & B are limited partners who are not obligated to restore a capital account deficit but the partnership agreement includes a qualified income offset?
1. Can't pass loss to A & B greater than their capital account. Allocated based on all the facts and circumstances b/c they cannot allocate 40/40/20. A & B would be allocated $20K each and C would be allocated $60K. C gets the $40K basis.
d) What result in (c) if A contributes $15K of stock to the partnership as security for the liability and all income, gain or loss on the stock is allocated to A? What result if A contributes his $15K note as security for the liability?
e) What result in (c) if A personally guarantees the $40K liability?
1. Assume all partners have money and will go against each other. If the lender goes after the guarantor, it has to pay, but then has the right to go against the original borrow (right of subrogation). So we still just allocate all the basis to C and ignore the guarantee b/c in the end A would have the right to go against C. A guarantee can make a big difference in an LLC or where there are no general partners.
(2) G & L form a limited partnership. G, the limited partner, contributes $10K and L, the limited partner contributes $90K. The partnership purchases a building on leased land, paying $100K cash and borrowing $900K on a nonrecourse basis from a commercial lender, securing the loan with a mortgage on the building. The terms of the loan require the payment of market rate interest and no principal for the first 10 years. The building is depreciable at the rate of $50K per year for 20, and that other partnership income equals expenses for the years in question. The partnership agreement contains a qualified income offset, and G is required to make up any capital account deficit. Except as otherwise required by a minimum gain chargeback provision, the agreement allocates profit and loss 90% to L and 10% to G until such time as the partnership recognizes items of income and gain that exceed the items of deduction and loss that it has recognized equally between G & L. Assume that it is reasonably anticipated that the equal allocation will begin after 10 years. The partnership agreement states that G & L each has a 50% interest in the partnership profits for purposes of 752.
a) How is the $900K liability allocated in year one?
b) How will the liability be allocated at the end of year three?
c) How will the liability be allocated at the end of years one and three if excess nonrecourse liabilities are allocated in a ratio of 90% to L and 10% to G?
d) What result in (a) if the debt is guaranteed by G, who has no right to reimbursement from the partnership? Does the result change if G has a gross assets of only $6K?
e) What result in (a) if the debt is guaranteed by L, and L has a right to reimbursement from the partnership?
f) What result in (a) if G is the lender?

Attachment:- partnership-tax.rar