Reference no: EM132705242

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.

Earlier this month, Blythe and Ella met with you to discuss the pros and cons of two options they are considering with respect to the property on 8th Avenue South held by Melrose Place, LLC. The first option is to sell the lot for $2,000,000 to an unrelated third party developer, who wants to build a mixed-use development on the site, and liquidate the LLC after repaying the loan. The second option is for Melrose Place, LLC to contribute the lot to Urban Development LLC, a newly formed Tennessee limited liability company, in exchange for a 50% membership interest; the other 50% membership interest will be held by a local developer. All items of profit, loss, gain or deduction will be allocated in accordance with each member's ownership percentage. Under the second option, the LLC will assume the debt encumbering the 5-acre tract.

1) Please explain the tax consequences to Melrose Place, LLC and its partners under this option (i.e., sale and liquidation) and how such consequences should be reported on the applicable tax returns.

2) What is the amount of the liquidating distribution for each partner? Assume that the Operating Agreement of Melrose Place, LLC provides that the LLC will liquidate in accordance with positive capital accounts.