South-Western Federal Taxation: Comprehensive Volume

CHAPTER 21 PARTNERSHIPS SOLUTIONS TO PROBLEM MATERIALS Status Q/P Question/ learn Present in Prior business objective lens upshot Edition Edition LO 1Partnership definitionNew 2LO 2General union versus LLCNew 3LO 1Check-the-box regulationsNew 4LO 2Partnership r tear downue reportingModified1 5LO 2Analysis of Income scheduleModified1 6LO 2Partnership Schedule M-3New 7LO 3Special allocationsNew 8LO 3 majuscule accountsNew 9LO 3Inside versus outside soilNew 10LO 4Comparison of corporate and leagueUnchanged2 treatment 11LO 4Application of 721New 12LO 4Exceptions to 721New 13LO 4Disguised bar polish off issue recognitionUnchanged4 14LO 5Initial be of a coalitionNew 15LO 6Cash score order for pardnershipsNew 16LO 7Economic effect testUnchanged8 7LO 8Adjustments to mates dry devourUnchanged9 18LO 8Liability allocations to reasonUnchanged10 19LO 10Guaranteed paymentsNew 20LO 8, 9, 14Partnership advantages and disadvantagesUnchanged12 21LO 4, 6, 7 ,Partnership formation and operationsUnchanged13 8, 9, 10issues 22LO 11Basis in distributed blank spaceUnchanged14 23LO 11Distribution ordering rules liquidatingNew versus nonliquidating scatterings 24LO 11 impressionual taxation results of distributionsNew 25LO 12Ramifications of exchange of a fusion pleaseNew t all(prenominal)er For difficulty, timing, and assessment information about apiece item, see p. 1-4. Status Q/P Question/ Learning Present in Prior Problem Objective Topic Edition Edition 6LO 4Formation of confederacy inside and buttUnchanged15 27LO 4, 14Formation of federation inside and outsideUnchanged16 outside grounding 28LO 4Contribution of various properties onUnchanged17 formation of a confederacy foothold and disparagement 29LO 4Formation of a unionNew 30LO 4Formation of a fusionNew 31LO 4, 8, 14Basis of seat received as gift receipt Modified19 of interest for operate 32LO 8, 14Planning for service interestsNw 33LO 4, 10, 14D isguised sale versus distributionUnchanged20 *34LO 4, 7Treatment of extendd holdingNew 5LO 5Tax issues cerebrate to formation ofUnchanged5 union 36LO 4, 5, 6,Preparation of sign LLC tax returnUnchanged6 37LO 6Accounting systemsUnchanged7 *38LO 5Definition of organization existUnchanged21 amortization of organization be *39LO 6Computation of confederacys required taxUnchanged24 grade infra the least aggregate deferral rule 40LO 4, 7Date grounding of partners interest enlighten on saleUnchanged25 of contributed land with precontribution built-in build 41LO 7Date rump of partners interest issue on saleUnchanged26 of contributed land *42LO 7, 8Computation of partners outside bag atModified27 beginning and end of year when several achievements took place *43LO 7, 8Partnership income partners cornerstoneModified28 each stated items guaranteed payments 44LO 7, 8, Partnership income partners basis tone endingModified29 10,limitations guaranteed payments 45LO 4, 7, 8Par tnerships income and separately statedUnchanged30 items partners basis and amount at risk 6LO 4, 7, 8Same as Problem 45 for an LLCModified31 47LO 7, 8, 9,Basis and loss limitationsUnchanged32 *48LO 4, 7, 8, parcellings under 704(b)Modified33 9 49LO 7, 8, 9Allocation of eluci see to it under 704(b)Modified33 50LO 7, 8, 9Allocations to partner basis in interest Unchanged34 loss limitations 51LO 8Allocation of recourse debtUnchanged35 52LO 4, 8Sharing recourse debt for basis pointsUnchanged36 Instructor For difficulty, timing, and assessment information about each item, see p. 21-4. Status Q/P Question/ Learning Present in Prior Problem Objective Topic Edition Edition 3LO 8, 9, 14Basis calculations and loss limitationsUnchanged11 54LO 8, 9Loss disallowance under 704(d), 465,Unchanged37 and 469 55LO 7, 10Timing of recognition of guaranteedModified38 payments 56LO 10Timing of recognition of guaranteed New payments, continued *57LO 7, 10Comparison of C locow eed salary versus Unchanged39 partnership guaranteed payment 58LO 10Disallowed 267 loss from sale of postUnchanged40 to partnership by partner conversion f roof attract to general income from sale of investment berth to partnership by partner 59LO 11Nonliquidating distribution basis of New assets distributed (limited) partners outside basis 60LO 11Nonliquidating distribution basis of New assets distributed (limited) partners outside basis *61LO 11Nonliquidating distributions amount andModified43 constitution of apply or loss basis of assets distributed partners outside basis *62LO 11Allocation of basis to multiple assetsUnchanged44 distributed 3LO 11Effect of change in partners distribute of New liabilities nonliquidating versus liquidating distributions 64LO 11Results of various liquidating distributionsUnchanged45 65LO 12Sale of partnership interest amount andModified46 face of benefit or loss basis of rising partners interest alternative to adjust basis of partnership piazza *The solution to this problem is available on a transpargonncy master. Instructor For difficulty, timing, and assessment information about each item, see p. 21-4. Status Q/P Research Present In Prior Problem Topic Edition Edition 1Economic effect allocationsUnchanged1 2Allocation of liabilitiesNew Internet activityUnchanged3 Estd Assessment nurture Question/ completion AICPA* AACSB* Problem Difficulty conviction Core Comp Core Comp 2 docile 10 FN-Reporting uninflected 3 Easy 10 FN-Reporting analytic 4 Easy 10 FN-Reporting analytic 5 mean(a) 10 FN-Reporting uninflected 6 fair 10 FN-Reporting uninflected 7 Easy 10 FN-Reporting Analytic 8 strength 10 FN-Reporting Analytic 9 Easy 10 FN-Reporting Analytic 10 Medium 10 FN-Reporting Analytic 11 Easy 10 FN-Reporting Analytic 12 Medium 10 FN-Reporting Analytic 13 Medium 10 FN-Measurement FN-Reporting Analytic thoughtful persuasion 14 Medium 10 FN-Reporting Analytic meditative Thinking 15 Medium 10 FN-Reporting Analytic 16 Easy 10 FN-Reporting Analytic 17 Easy 10 FN-Measurement Analytic 18 Medium 10 FN-Measurement FN-Reporting Analytic 19 Easy 10 FN-Reporting Analytic 20 Medium 10 FN-Measurement FN-Reporting Analytic 21 Medium 15 FN-Reporting Analytic 22 Easy 10 FN-Measurement FN-Reporting Analytic 23 Easy 5 FN-Measurement FN-Reporting Analytic 24 Easy 5 FN-Measurement FN-Reporting Analytic Reflective Thinking 25 Medium 10 FN-Measurement FN-Reporting Analytic Reflective Thinking 26 Easy 10 FN-Measurement FN-Reporting Analytic 27 Medium 10 FN-Measurement FN-Reporting Analytic Reflective Thinking 28 Easy 10 FN-Measurement FN-Reporting Analytic 29 Easy 10 FN-Measurement FN-Reporting Analytic 30 Medium 10 FN-Measurement FN-Reporting Analytic 31 large(p) 15 FN-Measurement FN-Reporting Analytic Reflective Thinking *Instru ctor See the Introduction to this supplement for a discussion of apply AICPA and AACSB core competencies in assessment. 32 Medium 10 FN-Reporting Analytic Reflective Thinking 33 Medium 15 FN-Measurement FN-Reporting Analytic Reflective Thinking 34 Medium 15 FN-Measurement FN-Reporting Analytic 35 Medium 10 FN-Measurement FN-Reporting Analytic Reflective Thinking 36 Medium 10 FN-Measurement FN-Reporting Analytic Reflective Thinking 37 Medium 10 FN-Reporting Analytic 38 Medium 10 FN-Measurement FN-Reporting Analytic 39 Medium 10 FN-Reporting Analytic 40 Medium 15 FN-Measurement FN-Reporting Analytic 41 Medium 15 FN-Measurement FN-Reporting Analytic 42 Medium 20 FN-Measurement FN-Reporting Analytic 43 Hard 15 FN-Measurement FN-Reporting Analytic 44 Hard 15 FN-Measurement FN-Reporting Analytic 45 Medium 15 FN-Measurement FN-Reporting Analytic 46 Medium 15 FN-Measurement FN-Reporting Analytic 47 Medium 15 FN -Measurement FN-Reporting Analytic 48 Medium 10 FN-Measurement FN-Reporting Analytic Reflective Thinking 49 Hard 10 FN-Measurement FN-Reporting Analytic 50 Hard 15 FN-Measurement FN-Reporting Communication Analytic 51 Medium 10 FN-Measurement FN-Reporting Analytic 52 Hard 15 FN-Measurement FN-Reporting Communication Analytic 53 Medium 15 FN-Measurement FN-Reporting Analytic Reflective Thinking 54 Hard 15 FN-Measurement FN-Reporting Communication Analytic 55 Medium 10 FN-Measurement FN-Reporting Analytic *Instructor See the Introduction to this supplement for a discussion of victimization AICPA and AACSB core competencies in assessment. 56 Medium 10 FN-Reporting Analytic 57 Medium 10 FN-Measurement FN-Reporting Analytic 58 Easy 10 FN-Measurement FN-Reporting Analytic 59 Medium 10 FN-Measurement FN-Reporting Analytic 60 Medium 10 FN-Measurement FN-Reporting Analytic 61 Medi m 10 FN-Measurement FN-Reporting An alytic 62 Medium 10 FN-Measurement FN-Reporting Analytic 63 Medium 5 FN-Measurement FN-Reporting Analytic 64 Medium 15 FN-Measurement FN-Reporting Analytic 65 Medium 15 FN-Measurement FN-Reporting Analytic *Instructor See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment. CHECK FIGURES 26. a. $0 $0. 26. b. $200,000. 26. c. $100,000. 26. d. $100,000 basis in plaza. 27. a. ($15,000) realized $0 have a go at itd. 27. b. $60,000. 27. c. $75,000. 27. d. $75,000. 27. e. Sell and contribute funds. 28. a. $20,000 on land $60,000 on equipment. 28. b. No gain under 721. 28. c. sing $70,000 Connie $30,000. 28. d. $40,000 basis in land $30,000 basis in equipment. 28. e. Inside = Outside = $100,000. 28. f. Partnership continues Connies wear and tear schedule. 29.No gain or loss to Justin, Tiffevery, or partnership Justins basis $85,000 Tiff whatsoevers basis $125,000 partnerships basis in land $65,000 par tnership steps into Tiffanys station for derogation. 30. Tiffany take ins $25,000 loss on sale basis is $100,000. Partnership moldiness spend additional $10,000 to acquire assets. 31. a. $0. 31. b. $50,000. 31. c. $25,000 ordinary income. 31. d. $75,000. 32. b. Contribute property of permits and development plan ideal before contribution. 33. a. Distribution. 33. b. $0 gain or loss. 33. c. $50,000. 33. d. Disguised sale. 33. e. $16,667. 33. f. $66,667. 34. a. Rachel $360,000 Barry $600,000. 34. b. 170,000 ordinary income. 34. c. $100,000 corking loss and $20,000 ordinary loss. 35. Organization costs $10,000 (deducted) start-up costs $60,000 (amortized all over 180 months) property acquisition costs $24,000 (added to property basis depreciated as newly acquired asset) syndication costs $1 billion (nondeductible). 36. Issues include partnership year end partnership accounting regularity treatment of sign costs partners bases in LLC interests LLCs basis in property received o n formation interests issued in exchange for work built-in gain on subsequently sale of land. 37. BR can enforce nones, accrual, or hybrid method in 2008, 2009, and 2010.In 2011 and later years, BR whitethorn no longer use cash method. 38. a. organisational costs $8,000 syndication costs $10,000. 38. b. $5,000 deduction plus $50 amortization of organization costs. 38. c. 180-month amortization. 39. January 31. 40. a. $75,000. 40. b. Five years. 40. c. $15,000 gain. 41. a. $36,000 loss $30,000 to Reece and be $6,000 allocated equally among partners. 42. a. $160,000. 42. b. $230,000. 43. a. $42,000 qualified dividends $4,000. 43. b. $29,000 basis. 43. c. $22,000 basis. 44. a. ($18,000) qualified dividends $4,000. 44. b. $0 basis $8,000 loss deductible up-to-dately, $1,000 suspended. 44. c. $0 basis $1,000 loss allowed $8,000 suspended. 45. a. 175,000 (Celeste) $125,000 (Ernestine). 45. b. Ordinary income $80,000 qualifying dividend $3,000 tax-exempt interest $1,000 eleemosyna ry contribution $500 distribution to Celeste $20,000. 45. c. $283,500 basis and at-risk amount. 46. a. Accounts payable ar nonrecourse for LLC. 46. b. $283,500 basis $233,500 amount at risk. 47. a. $24,000. 47. b. $4,000. 47. c. $0. 47. d. $4,000. 47. e. Don can contribute bang-up or partnership can incur debt. 48. a. Year 1Fred $49,600 Manuel $78,400. Year 2Fred $960 Manuel $75,840. 48. b. Yes. 49. a. Gain $43,200 allocated equally. BasisFred $22,560, Manuel $97,440. 49. b. Freds cash $22,560 Manuels cash $97,440. 49. c.Tax savings now or cash later non both. 50. Deduct $54,000 of loss unless basis increased before year-end. 51. Melinda $6,000 Gabe $6,000 Pat $18,000. 52. Paul $160,000 Anna $80,000. 53. a. Basis tolerance rules per Figure 21. 3 at that placefore loss limitation rules 704(d), 465, then 469. 53. b. $5,000 gain, $0 basis. 53. c. No loss deduction. 53. d. Make distribution next year so Brad can deduct loss this year. Partnership can incur additional debt. 54. $ 48,000 deducted. $14,000 suspended 704(d) $8,000 suspended 469. 55. a. $70,000 in 2010, incl. guaranteed payment. 55. b. $25,000 in 2010. 56. $70,000. 57. a. $55,000 salary in 2010. 57. b. 0 in 2010 $40,000 partnership income and $60,000 guaranteed payment in 2011. 58. a. $0. 58. b. $10,000. 58. c. $80,000 gain whitethorn be ordinary. 59. a. $0. 59. b. $0. 59. c. Inventory $60,000 land $75,000 partnership interest $185,000. 60. a. $0. 60. b. $0. 60. c. Account receivable $0 land $20,000 partnership interest $0. 61. a. $15,000 gain and basis in partnership interest $0 partnership $0 gain. 61. b. Land $30,000 basis and basis in partnership $10,000 partnership $0 gain. 61. c. No gain or loss land basis $12,000 basis in partnership interest $0. 61. d. $10,000 gain $0 basis in enumeration $0 basis in partnership interest. 62. a. No gain or loss. 62. b. 6,000 in item 1 and $3,000 in item 2. 63. a. Inventory basis $10,000 basis in partnership interest $20,000. 63. b. Recognized loss $20,0 00 Inventory basis $10,000. 64. a. $15,000 jacket crown gain. 64. b. No gain or loss $40,000 basis. 64. c. No gain or loss inventory $10,000 capital asset $22,000. 64. d. $0 basis in accounts receivable $60,000 capital loss. 65. a. $100,000 realized. 65. b. $30,000 ordinary income. 65. c. $20,000 capital gain. 65. d. $100,000 basis. DISCUSSION QUESTIONS 1. A partnership is an association of two or more persons (including individuals, trusts, estates, piles, separate partnerships, and so on ) formed to carry on a trade or business.Each partner contributes money, property, labor or skill, and each expects to sh be in profits and losses. The entity must non otherwise be classified as a corporation, trust, or estate. p. 21-3 2. In a everyday partnership, all partners ar world-wide partners who are jointly and severally liable for partnership debts, including liabilities arising from tort or malpractice judgments against the general partnership. A general partner bears liability for these debts even if the partner was not personally involved in the malpractice. A limited liability fellowship has the corporate attribute of limited liability for the owners (called members in an LLC), but an LLC is tempered as a partnership for tax purposes.In a properly-structured LLC, none of the members are personally liable for entity debts. State law governs the types of entities that may be established as LLCs. close to states permit capital-intensive entities to use this form of business, but they do not permit personal-service entities to be do by as LLCs. pp. 21-3 and 21-4 3. By default, a newly-formed noncorporate entity with two more owners is treated as a partnership under the check-the-box Regulations. The entity may check-the-box on Form 8832 to elect, instead, to be taxed as a corporation. p. 21-4 4. A partnership is not a tax-paying entity however, it must still file a tax return.The partnership reports its income and expenses on Form 1065. Partnership inco me is comprised of income from operations and separately stated income and expenses. The income and expenses from operating activities are reported on Page 1 of the Form 1065. A separately stated item is any item (income or expense) that could differently affect the tax liabilities of different partners. separately stated items are reported in the partnership return on ScheduleK. The partners must pay the tax on the partnership income. The partnerships income and separately stated items are reported to each partner on a Schedule K-1 prepared for that partner. pp. 21-4 to 21-7 5.Because it is not a tax-paying entity, a partnership does not report ratable income. However, it must still reconcile among the tax return and the books. The partnership prepares the Analysis of Net Income (Loss) (page 5 of Form 1065) to intend what competency be called the partnerships taxable income akin. Certain amounts shown on Schedule K are netted and entered on the Net Income (loss) line of thi s Analysis. This taxable income similar is reconciled to book income on Schedule M-1 or Schedule M-3 of the partnerships return. This is equivalent to the corporate reconciliation ( alike on Schedule M-1 or M-3) in Form 1120 however, for a partnership, the taxable amount must be derived as described above. pp. 1-5 to 21-7 6. Schedule M-3 is filed (in lieu of Schedule M-1) by larger partnerships to report a detailed reconciliation between the partnerships book and tax income. In addition, these partnerships must file Schedule C to answer various questions regarding the partnerships changes of ownership, reporting, or other activities during the year. This reconciliation is designed to highlight differences between GAAP basis reporting (per an SEC filing or an audited financial statement) and tax basis income. A partnership is generally required to file Schedule M-3 if it has $10 million or more in assets or $35 million or more in total profit.In addition, it must file Schedule M-3 if any partner owns a 50%-or-greater interest in partnership profits, losses, or capital, and if that partner meets any the $10 million (assets) or $35 million (receipts) threshold. pp. 21-6 and 21-7 7. A special allocation is an amount that is allocated differently from the general profit or loss sharing ratios specified in the partnership agreement. For pre-contribution gain or loss property, special allocations are required to be do to eventually add up the partners tax bases in line with their book-value capital accounts. Orange, LLC, can offer a preferential special allocation of profits and cash flows to Green to compensate the company for use of its capital.The LLC can offer a guaranteed payment (rather than a special allocation) to Rose for her managerial time and expertise. Upon sale of the appreciated property contributed by Rose, 704(c) requires the precontribution gain to be allocated to her. pp. 21-8, 21-24, and 21-36 8. A partners capital account is a mechanical d etermination of the partners financial interest in the partnership, as determined using one of several possible accounting methods, including tax basis, GAAP, 704(b) book basis, or some other method defined by the partnership. The capital account reflects contributions and distributions of cash or other property to or from the partner.In addition, it accumulates the partners share of increases and decreases from operations, including amounts that are otherwise tax-exempt or nondeductible. Even if capital accounts are determined on a tax basis, a partners capital account usually volition differ from the partners basis in the partnership interest because (among other reasons) the capital account does not include the partners share of partnership liabilities. p. 21-8 9. The inside basis is the partnerships tax basis for the assets it owns. The outside basis is a given partners tax basis in the partnership interest. On formation of a partnership, the total of all partners outside bases testament equal the partnerships inside bases of all of its assets. p. 21-8 10.As a general rule, both 721 and 351 provide that no gain or loss is recognized when property is transferred on the formation of a partnership or corporation. However, 351 applies however if those persons transferring property to a corporation are in control of the corporation immediately after the exchange, whereas 721 does not include a control requirement. Section 721 not only applies to initial transfers in forming the partnership but to all subsequent contributions from any partner. Similarities populate between 721 and 351 in that these nonrecognition provisions do not apply to all transfers made by the owners. Under 721, the contributor must receive an interest in the partnership, while under 351, the transferor must receive stock in the corporation.Under both 721 and 351, if the transfer of property involves the receipt of money or other consideration, the execution may be deemed a sale or exc hange rather than a tax-free transfer. pp. 21-9 to 21-11, and Concept Summary 21. 1 11. In general, on formation of a partnership, no gain or loss will be recognized by either the partnership or the contributing partners 721. Bobbi will not recognize the realized gain related to the land she is contributing. Similarly, BC will not recognize a gain or loss. Bobbis basis in the land will carry over to BC. Bobbis basis in BC will be a substituted basis equal to her basis in the contributed land. If the land Bobbi contributes is ever exchange by BC, the precontribution gain must be allocated to Bobbi 704(c). pp. 21-9, 21-10, and Example 24 12.Under the general rule of 721(a), no gain or loss is recognized on formation of a partnership. This rule does not apply in at least four situations. Realized gain or loss is recognized if The entity is an investment partnership, The partner received the interest in the partnership in exchange for services, The transaction can be viewed as an ex change of properties (e. g. , properties are contributed to the partnership and soon thereafter are distributed to other partners with the intent of taking advantage of the basis rules of 731 for distributed property), and The transaction can be viewed as a hide sale of the property from the partner to the partnership or one of the other partners. pp. 21-10 to 21-11 13. a.If a contribution of property to a partnership is followed shortly thereafter by a distribution of cash to that partner, the IRS may recharacterize the transactions as a disguised sale of the property. In this case, Gerald would be treated as contributing 75% of the property and selling the rest 25% for cash $60,000 sales determine (distribution amount) ? $240,000 property value. He would recognize $30,000 of gain on the deemed disguised sale $60,000 deemed selling price less $30,000 basis ($120,000 ? 25%). b. The parties could use any of several techniques to minimize the possibility that the IRS will recharac terize the transaction as a sale. First, the distribution could be proportionate to all the partners. Second, the contribution should not be contingent on the later distribution of cash.Third, even if cash is required to ensure the contribution, the distribution should not be contingent on the partnership achieving a certain level of profits. Fourth, the distribution could be made in stages over a longer (say, three-year) time point in time. Here, it may be viewed as universe a reasonable return of Geralds capital (e. g. , each $20,000 payment represents a 10% return on his capital). Finally, the distribution could be deferred until two years next the capital contribution. pp. 21-11, 21-12, and Example 12 14. In its initial year, a partnership will typically incur organizational and startup expenses. If property is contributed to the partnership, the entity may incur costs related to transferring the title of the property.If the partnership interests are sell to investors, the pa rtnership might incur syndication costs. Once the partnership has started business, it will incur ordinary and necessary business expenses these expenses are deductible under 162. Organizational and startup costs are generally deductible to the extent of the first $5,000 of much(prenominal)(prenominal) costs. This deductible amount is reduced to the extent the total of such costs (in the respective category) exceeds $50,000. Any portion that is not deductible is amortized over 180 months, beginning with the month in which the partnership begins business. The cost of selling the partnership interests to investors is treated as a syndication cost under 709. Such expenses are not deductible.The cost of transferring title to an asset is treated as an acquisition cost related to the asset this amount will be treated as a new asset placed in service when incurred, and it will be depreciated using the same method and life as the underlying property. (If this underlying property was contri buted by a partner, that property will be depreciated by continuing the depreciation schedule used by the contributing partner. The partnership steps into the shoes of the contributing partner in calculating depreciation deductions. ) pp. 21-15 and 21-16 15. A partnership may generally use the cash method of accounting unless it is a tax shelter or has one or more partners that are subchapter C corporations.The C corporation partner will not preclude use of the cash method of accounting if that corporation is a qualified personal service corporation or if it is engaged in the farming business. In addition, a subchapter C corporate partner will not preclude use of the cash method if the partnership has never had average annual gross receipts in excess of $5 million, for any year beginning in 1986 or later years. Average annual gross receipts is calculated by averaging the taxpayers gross receipts for the three years prior to the tax year in question or for the period of the taxpayers existence, if shorter. p. 21-17 16. The three rules of the economic effect test are designed to ensure that a partner bears the economic rouse of a loss or deduction allocation and receives the economic benefit of an income or gain allocation.By increasing the partners capital account by the gain or income allocated to the partner, the rule ensures that a positive capital account partner will receive an allocation of assets equal to the balance in the partners capital account when the partners interest is eventually liquidated. If the partner has a negative capital account, an allocation of gain or income to the partner reduces the amount of the negative capital account and, therefore, the amount of the deficit capital contribution that is required from the partner upon liquidation. In short, a dollar of income or gain increases the partners capital account by a dollar and, everything universe equal, the partner should receive a dollar more upon liquidation (or contribute a dolla r less to restore a deficit in the capital account). Allocations of losses and deductions affect the partner in the opposite manner as income or gain.Therefore, the allocation of a dollar of loss or deduction reduces the partners capital account by a dollar and, everything being equal, reduces the amount the partner will receive upon liquidation (or increases by a dollar the partners deficit capital restoration requirement). p. 21-23 and Example 22 17. Under 722, a partners initial basis is determined by reference to the amount of money and the basis of other property contributed to the partnership. This basis is increased by any gain recognized under 721(b) and the partners share of any partnership liabilities. Basis is decreased by any partner liabilities assumed by the partnership.Basis is also modify to reflect the effect of partnership operations it is increased by the partners share of taxable and nontaxable income and is decreased by the partners share of loss and nondeduc tible/noncapitalizable expenses. Certain adjustments for depletion are also made. Finally, a partners basis is increased by additional contributions to the partnership and by increases in the partners share of partnership debt. Basis is decreased by distributions from the partnership and decreases in the partners share of partnership debt. A partners basis is adjusted any time it may be necessary to determine the basis for the partnership interest, for example, when a distribution was made during the taxable year, or at the end of a year in which a loss arises. A partners basis may never be reduced below zero (i. e. , no negative basis). Figure 21. 3 18.The partnerships debts are allocated to the partners in determining the partners bases in their partnership interests. Any increase in partnership liabilities is treated as a cash contribution to the partnership, thereby increasing the partners bases. Any decrease in partnership liabilities is treated as a distribution from the partn ership to the partners and decreases their bases. Partnership debt is allocated differently depending on whether it is recourse to the partners or nonrecourse. Recourse debt is allocated in accordance with the constructive liquidation scenario. Under this test, all partnership assets are deemed to be worthless.The losses that would arise are allocated to the partners according to the partnership agreement. The losses would create negative capital accounts for at least some of the partners those partners are deemed to contribute that amount of cash (equal to the negative capital balance) to the partnership in settlement of the obligation to repay partnerships recourse liabilities. The amount of that deemed capital contribution is the amount of the partners share of the recourse liabilities. Nonrecourse debt is allocated in a three-tier system. First, allocate any gain related to assets where the debt exceeds the partnerships book basis in the assets. This is called minimum gain and i s allocated according to the partnership agreement.Next, any debt related to any remaining precontribution gain is allocated to the partner who contributed the encumbered property to the partnership. Finally, any remaining debt is allocated in accordance with the method specified in the partnership agreement. pp. 21-28 and 21-29 19. A guaranteed payment is an amount paid to a partner for the performance of services or for the use of the partners capital. These payments are in the nature of salary or interest payments that are made by other entities, but the tax treatment of guaranteed payments is somewhat different. Like payments made by other entities, guaranteed payments are generally deductible by the partnership, and can result in a loss to the entity. Guaranteed payments are taxed as ordinary income to the recipient partner.Unlike salary and interest payments made by other entities, guaranteed payments are treated as if they were received by the partner on the last day of the p artnerships tax year. If the partner and partnership have different tax years, there will be a deferral between the time the partnership claims the deduction and the time the partner reports the income. Guaranteed payments are treated as self-employment income by the recipient partner. pp. 21-36 and 21-37 20. A partnership is advantageous under any of the following conditions Special allocations of income, expenses, cash flows, etc. can be made by the entity owners. The entity has taxable losses which the owners can utilize on their individual tax returns. The partnership gene grade net resistless income which offsets passive losses of the owners. The entity operated as a Subchapter C corporation and would be required to report taxable income since other means of reducing such income (e. g. , interest, rents, salaries to owners) have been maximized and are not available. The entity cannot qualify under the requirements for a Subchapter S election (e. g. , too many shareholders, nonqualifying shareholders, more than one outstanding class of stock, etc. ) The entity will exist for only a short period of time and, if a corporation, its liquidation will result in a large tax due to the appreciation in its assets. Several other advantages may exist. The disadvantages of the partnership entity form arise when The entity income is significant and will be taxed at higher individual rates than if accumulate in the corporation. The entity is in a high risk business and the owners require protection from personal liability. An LLC or LLP may be useful in such situations. pp. 21-51, 21-52, and Concept Summary 21. 5 21. a. False. The entity is required to file an information return, generally by the fifteenth day of the fourth month after the end of the partnerships tax year. The return includes data concerning the partners allocable shares of the financial activities of the partnership. In addition, property, sales, and employment tax returns are likely to be re quired of the entity. p. 21-6 b. False.Generally no gain or loss is recognized, but there are exceptions to 721, including those pertaining to the receipt of boot, the contribution of property with liabilities in excess of basis, and the receipt of a partnership interest in exchange for services provided to the partnership. pp. 21-10 and 21-11 c. False. The partner recognizes ordinary income, to the extent of the fair market value of the partnership interest that is received in this manner. p. 21-11 d. False. If property which was inventory in the hands of the transferor partner is sold by the partnership within five years of the date it was contributed, any gain will be treated as ordinary income, regardless of the manner in which the property was held by the partnership. p. 21-13 e. False. The partnership chooses tax accounting periods and methods that are applied to all of the partners. p. 21-15 f. False.An alternative tax year will never be required by the IRS instead, the part nership must request permission from the IRS and may have to illustrate to the IRS that it has a business purpose for using an alternative tax year. p. 21-19 g. True. Built-in losses, as well as gains, must be allocated to the contributing partner when recognized by the partnership. pp. 21-24 and 21-25 h. True. pp. 21-27 to 21-29 i. True. p. 21-33 j. False. Such losses can be deducted by partners who hold a 50% or less ownership interest in the entity. p. 21-38 22. Generally, a taxable gain arises on a proportionate distribution only when cash is received in excess of the distributee partners basis in the partnership interest. As a relief of liabilities is treated as a distribution of cash, a decrease in a partners share of liabilities may also spark off a taxable gain.Similarly, certain distributions of marketable securities are treated as distributions of cash and can result in gain recognition. Other transactions, such as disguised sales and distributions related to precontribut ion gain property, might also result in gain recognition by the distributee partner. pp. 21-41 and Examples 51, 52 and 57 23. In either a current or liquidating distribution, assets are distributed in the following order 1)cash, 2) ordinary-income producing (hot) assets, and 3) other assets. Cash. In either a current or liquidating distribution, a cash distribution in excess of the partners basis triggers a gain (typically a capital gain). Cash (and certain items treated as cash) is the only asset for which a distribution might trigger a gain. Hot assets.In either a current or liquidating distribution, the partners basis in distributed hot assets equals the lesser of the partners basis in the partnership interest (after any cash distributions) or the partnerships basis in the hot asset. In a liquidating distribution, the partner can claim a loss equal to any basis remaining after these hot assets are distributed, if no other assets will be distributed. In a current distribution, no loss can be deducted. Other assets. In a current distribution, other assets are treated similarly to hot assets the basis equals the lesser of the partners basis in the partnership interest (after any cash and hot asset distributions) or the partnerships basis in the asset. In a liquidating distribution, other assets absorb any remaining basis in the partnership interest after cash and hot assets are accounted for.For either a current or liquidating distribution, if other assets are distributed, the partner cannot recognize a loss. Examples 54, 57, 59, and 60 24. The partnership distribution rules reflect the aggregate theory of taxation. With respect to property ownership, the partner can be seen as an extension of the partnership. Ownership of property by the partner generally produces the same result as ownership by the partnership (and vice versa). The result is a carryover basis in distributed property with a preservation of the character of distributed property. The distributi on rules operate with the goal of deferring tax on the distribution, while preserving the ordinary income potential.No gain or loss is recognized if an adjustment can be made to the basis of the distributed property, without reducing the amount of ordinary income the partner will eventually recognize. So, gain is recognized if cash distributions exceed basis, because there is no asset for which the basis can be reduced. The basis of hot assets can be decreased, but not increased, in a distribution because the innate ordinary income cannot be decreased. Similarly, loss can be recognized if only cash and hot assets are received in a liquidating distribution, because the basis in these types of assets cannot be increased to absorb the partners remaining basis. pp. 21-40 and 21-41 25.Jody must determine her gain or loss on the sale of the partnership interest. If the partnership owns hot assets, she must recognize ordinary income or loss to the extent of her proportionate share of the built-in appreciation or depreciation on these assets. Her remaining gain or loss is adjusted by the ordinary income or loss recognized. If the partnerships assets are lustyly appreciated, note may want to ask the partnership to make a 754 election so he can be allocated a step-up in basis. If the partnership has a substantial built-in loss (assets are depreciated by more than $250,000), the partnership may be required to make a step-down adjustment with respect to Bills acquired interest.If Jody sells more than a 50% interest in the partnership, or Bill is the sole remaining member of a two-owner partnership, the entity will terminate on the date the purchase is finalized. This may result in a loss of a favorable tax year or accounting method by the partnership. pp. 21-47 to 21-49 PROBLEMS 26. a. Under 721, neither the partnership nor the partners recognizes any gain on formation of the entity. b. Chip will analyse a cash basis of $200,000 in his partnership interest. c. Mart y will take a substituted basis of $100,000 in his partnership interest ($100,000 basis in the property contributed to the entity). d. The partnership will take a carryover basis in the assets it receives ($200,000 basis in cash, and $100,000 basis in property). Example 14 27. a. Liz has a realized loss of $15,000.However, 721 contains the general rule that no gain or loss is recognized to a partnership or any of its partners upon the contribution of money or other property in exchange for a capital interest. Since Liz is subject to this rule, she does not recognize the loss. p. 21-10 b. $60,000. Section 722 provides that the basis of a partners interest acquired by a contribution of property, including money, is the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution. p. 21-12 c. $75,000, the adjusted basis of the contributed property ( 722). p. 21-12 d. $75,000. Under 723, the basis of property to the entity is the adjusted basis of such property to the contributing partner at the time of the contribution, increased by any 721(b) gain recognized by such partner.Since no such gain (and no loss) was recognized by Liz on the contribution, the partnership takes a carryover basis in the property. Example 14 e. A more efficacious tax result may arise if Liz sells the property to an unrelated party for $60,000, recognizes the $15,000 loss on the property, and contributes $60,000 cash to the partnership. The partnership could then use the $60,000 to acquire similar property, in which it would take a $60,000 basis. Example 9 28. a. Carol realizes a gain of $20,000 on contribution of the land. Connie realizes a gain of $60,000 on contribution of the equipment. The partnership realizes a gain equal to the value of the property it receives (it has a $0 basis in the partnership interests it issues). b.Under 721, neither the partnership nor either of the partners recognizes any gain on formation of t he entity. Example 8 c. Carol will take a substituted basis of $70,000 in her partnership interest ($30,000 cash plus $40,000 basis in land). Connie will take a substituted basis of $30,000 in her partnership interest ($30,000 basis in the equipment). Example 14 d. The partnership will take a carryover basis in all the assets it receives ($30,000 basis in cash, $40,000 basis in land, and $30,000 basis in equipment). p. 21-12 e. The partners outside bases in their partnership interests total $100,000 Carols basis of $70,000 plus Connies basis of $30,000.This is the same as the partnerships basis in assets of $100,000 ($30,000 cash plus $40,000 land plus $30,000 equipment). p. 21-12 f. The partnership will step into Connies shoes in determining its depreciation expense. It will use the remaining depreciable life and the same depreciation rates Connie would have used. p. 21-12 29. Both partners are contributing assets valued at $100,000. One property has a built-in gain the other has a built-in loss. Justin and Tiffany recognize no gain or loss on contribution of their respective properties to the partnership. Justin takes a substituted basis of $85,000 in his partnership interest ($20,000 cash plus $65,000 basis in land). The partnership takes a $65,000 carryover basis in the contributed land.The built-in gain on the land must be tracked and allocated to Justin if the property is ever sold at a gain 704(c). Section 721 applies to losses as well as gains and prevents Tiffany from recognizing the $25,000 loss on her contribution to the partnership. She will have a $125,000 basis in a partnership interest worth $100,000. Similarly, the partnership will have a $125,000 basis in assets valued at $100,000. The partnership will step into Tiffanys shoes in determining depreciation deductions. As this is built-in loss property, 704(c) applies, and amounts related to the built-in loss must be allocated to Tiffany. disparagement must be allocated in accordance with Reg. 1. 704-3 (not discussed in detail in this chapter). Basically, a large portion of the depreciation deductions would be allocated to Tiffany to reduce the difference between her basis and the fair market value of her partnership interest as quickly as possible. (If the property basis was less than its fair market value, depreciation would first be allocated to the other partner. ) pp. 21-10, 21-12, 21-13, 21-24, and Example 9 30. Tiffany has a taxable transaction when she sells the assets to a third party. She receives cash of $100,000 in exchange for assets with a basis of $125,000 and recognizes a $25,000 loss. (Based on the facts presented, the loss will likely be a 1231 loss. ) When Tiffany contributes the $100,000 cash to the partnership, she recognizes no gain or loss and has a basis of $100,000 in her partnership interest.The partnership, of course, has a basis of $100,000 in the cash it receives. The partnership will need to use Tiffanys $100,000 cash contribution, plus $10,000 of the cash Justin contributed to acquire new equivalent assets for $110,000. In this situation, the tax result to Tiffany is improved (she can recognize her $25,000 realized loss), but there is a $10,000 economic cost to the partnership when it acquires equivalent assets for $110,000 instead of $100,000. pp. 21-10, 21-12, 21-13, 21-24, and Example 8 31. a. None. Under 721, neither the partnership nor any of the partners recognize gain on contribution of property to a partnership in exchange for a partnership interest. b. $50,000.Bens basis in his partnership interest will equal the basis he held in the property he inherited from his father. The basis a beneficiary takes in property received from an estate generally equals the fair market value of the asset at the date of death or at the alternate valuation date (6 months later) if available and elected. p. 21-26 c. Beth will recognize $25,000 of ordinary income. The fair market value of Beths 50% partnership interest is $75,000. Since Beth will contribute only $50,000 of property, the difference between the amount contributed and the value of the interest will be treated as being for services rendered to the partnership. Services do not constitute property for purposes of 721 nonrecognition treatment. p. 21-11 d.Beths basis in her partnership interest will be $75,000 $50,000 (cash contributed) + $25,000 (the amount of ordinary income recognized for services rendered to the partnership). Example 13 32. a. Assets Basis FMV Cash $ 50,000 $ 50,000 Land50,00075,000 Land improvements 25,000 25,000 Total assets$125,000$150,000 Bens capital $ 50,000 $ 75,000 Beths capital 75,000 75,000 Total capital$125,000$150,000 rase that the partnership will capitalize the $25,000 deemed payment for Beths services, since the services relate to a capitalizable expenditure. The partnership will reflect this $25,000 in cost of lots sold as the development lots are sold. b.Beth could prepare a development plan and secure zoning permits before the partnership is formed. She could then contribute these plans and permits to the partnership in addition to the $50,000 cash. Since a completed plan would be considered property, no portion of her partnership interest would be received in exchange for services if this were done. The entire transaction would be considered under 721. p. 21-12 33. a. Under general guidelines, the $50,000 would be treated as a distribution, which, since it does not exceed Bens basis in his interest, would not be taxable. The distribution would reduce Bens basis in his partnership interest by $50,000. b. None. c.The partnership would take a basis of $50,000 in the land, Bens basis in the property at the time of the contribution. d. The IRS might assert that the contribution and distribution transactions were in effect a disguised sale of two-thirds ($50,000 distribution ? $75,000 fair market value) of the property contributed by Ben to the partnership. e. $16,667. Under disguised sale treatment, Ben will recognize gain on a sale of two-thirds of his interest in the land. He will be deemed to have received $50,000 in exchange for two-thirds of the land, with a basis of $33,333 ($50,000 basis ? 2/3). Total gain recognized, then, is $16,667. f. $66,667. The partnership will be deemed to have paid $50,000 for two-thirds of the land.The remaining one-third is deemed to be contributed to the partnership, and the partnership will take a carryover basis of $16,667 in this parcel. The partnerships total basis is $66,667 ($50,000 + $16,667). Figure 21. 3 and Example 12 34. a. The partners initial bases in their partnership interests are the same amounts as their bases in the contributed property ( 722). Rachels basis $360,000 Barrys basis 600,000 b. The 2011 sale results in ordinary income of $170,000 to the partnership. 2011 sale Selling price$530,000 Basis (360,000) Gain$170,000 The gain is ordinary income, since the land is held as inventory by the partnership. The land was a capital asset to Rachel, but no code provision allows treatment of the gain based on Rachels use rather than the partnerships use. c.The 2012 sale results in a $100,000 capital loss and a $20,000 ordinary ( 1231) loss. 2012 sale Selling price$480,000 Basis (600,000) Loss ($120,000) As a sale of inventory (determined at the partnership level), the sale in 2012 of the land contributed by Barry would normally result in an ordinary (1231) loss. However, 724 overrides the usual treatment. The character of the precontribution loss, instead, is determined based on the character of the property in Barrys hands. This sale was within five years of the capital contribution date, so the loss is capital in nature to the extent of the built-in loss at the contribution date, which is FMV at contribution$500,000 Basis (600,000) Capital loss ($100,000)The remaining $20,000 loss in 2012 is an ordinary ( 1231) loss because the character of the post-contribution loss is based on the partnerships ownership and use of the property as inventory. d. If the property Barry contributed was sold by the partnership in 2017, the entire $120,000 loss would be treated as an ordinary (1231) loss. A sale in 2017 would not be within five years of the contribution date, so the character of the loss would be determined solely by reference to the character of the asset to the partnership. Since the land is inventory to the partnership, the loss in 2017 would be ordinary. pp. 21-12, 21-13, and Examples 16 and 17 35. P5 Partnership, Ltd. has incurred costs for organizing ($10,000), starting the business ($60,000), transferring of property ($24,000), and securing investors ($1million) for the partnership. The organizational costs are treated under 709. Under this section, the first $5,000 of such expenses are deducted (provided the total is less than $50,000) the remainder is amortized over 180 months. The startup costs are treated under 195. Under this section, also, the first $5,000 of suc h expenses are deducted, provided the total is less than $50,000. If costs exceed $50,000, the $5,000 deduction is phased out, dollar for dollar, by the amount of costs in excess of $50,000. When total costs equal or exceed $55,000 (as in this situation), no portion of the expense is currently deductible.Instead, the full amount is amortized over 180 months. The $24,000 transfer tax is treated as a cost of acquiring the land and is added to the partnerships basis in the land. The $1 million of brokerage commissions is treated as a syndication cost of the partnership. Under 709, these costs cannot be deducted. pp. 21-15 to 21-17 36. The SB Limited Liability Company must address the following issues in preparing its initial tax return What year-end must the LLC use? Unless an election is made under 444, the LLC must use the year-end determined under the least aggregate deferral method. There is no majority member, and the principal members do not have the same year-end.Under the lea st aggregate deferral method, the LLC would use a July year-end since this would result in only a 5-month deferral of income to Block. Example 19 What method of accounting will the LLC use? Even though both members are Subchapter C corporations, the LLC may elect the cash method of accounting if average annual gross receipts are less than $5 million for the year. The LLC, then, could select either the cash, accrual, or a hybrid method of accounting. p. 21-17 How are the initial legal fees treated? Can the first $5,000 of organizational expenditures be immediately expensed and the balance amortized over a period of 180 months or more? Would any amounts be treated as startup expenditures under 195? p. 21-15 The members initial bases in their LLC interests must be determined. The bases will be the substituted basis of the assets contributed to the LLC ($650,000 for Block, and $550,000 for Strauss). Example 14 The LLCs basis in the property received from the members must be determin ed, and any cost recovery related to contributed property calculated. The LLC takes a basis of $650,000 in the equipment and steps into Blocks shoes in determining cost recovery allowances. Since the licenses and drawings are contributed rather than sold, the LLC takes a $0 basis in these assets, with no cost recovery possible. The LLC takes a $50,000 carryover basis in the land and a $500,000 basis in the cash. p. 21-12 The LLC must determine whether any portion of either of the LLC interests is issued in exchange for services. The equipment, cash, and land are considered property for purposes of 721. The building permits and architectural designs also are considered property under 721, even though they are intangible assets. Therefore, none of the LLC interests is issued in exchange for services. Example 13 Treatment of expenses incurred during the initial period of operations must be considered. The legal fees are organization costs and their tax treatment was previously noted . The construction costs must be capitalized until such time as the building is placed in service. The office expense may have to be capitalized under either (1) 195, if it is etermined that the business is still in the startup stage, or (2) 263A if it is determined the costs relate to production of the rental property. If neither of these provisions applies, the office expense is currently deductible. pp. 21-15 and 21-16 If the land is later sold, a portion of the gain must be allocated to Strauss, since the gain was built-in at the time the property was contributed. Note that if the equipment had been appreciated, depreciation allocations would have to take the precontribution gain into account. Allocation of precontribution deductions related to depreciable property are not covered in this text. p. 21-24 37. In 2008, 2009, and 2010, BR can use either the cash, accrual, or a hybrid method of accounting.BR has at least one Subchapter C corporation as a partner, but BRs average a nnual gross receipts did not exceed $5,000,000 in either 2008 or 2009. (BRs average annual gross receipts were $4,600,000 for 2008 and $4,800,000 for 2009. ) In 2011, BR must change to the accrual method of accounting. BR has at least one Subchapter C corporation as a partner during that year, and BRs average annual gross receipts for the preceding y