CHAPTER 21 SOLUTIONS
END OF CHAPTER QUESTIONS COVERED IN LECTURE – NOT
7, 8, 9, 10, 11, 14, 15, (15 Not Included Homework Problem), 16, 17, 25, 26, 27, AND
7. In 2005, 2006, and 2007, 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 BR’s average
annual gross receipts did not exceed $5,000,000 in either 2005 or 2006. (BR’s average
annual gross receipts were $4,600,000 for 2005 and $4,800,000 for 2006.)
In 2008, BR must change to the accrual method of accounting. BR has at least one Subchapter C
corporation as a partner during that year, and BR’s average annual gross
receipts for the preceding years exceeded $5,000,000. (Average annual gross receipts for
the period ending in 2007 were $5,200,000.)
pp. 21-16 and 21-17
8. Under § 722, a partner’s 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 partner’s share of any partnership liabilities.
Basis is decreased by any partner liabilities assumed by the partnership.
Basis is also adjusted to reflect the effect of partnership operations: it is increased by the
partner’s share of taxable and nontaxable income and is decreased by the partner’s share
of loss and nondeductible/noncapitalizable expenses. Certain adjustments for depletion
are also made. Finally, a partner’s basis is increased by additional contributions to the partnership
and by increases in the partner’s share of partnership debt. Basis is decreased by distributions
from the partnership and decreases in the partner’s share of partnership debt.
A partner’s 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 partner’s basis may never be reduced below
zero (i.e., no negative basis).
9. The three rules of the economic effect test are designed to ensure that a partner bears the
economic burden of a loss or deduction allocation and receives the economic benefit of an
income or gain allocation. By increasing the partner’s 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 partner’s capital account when the
partner’s 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 partner’s
capital account by a dollar and, everything being equal, the partner should receive a dollar
more upon liquidation (or contribute a dollar less to restore a deficit in the capital account).
Allocations of losses and deductions affect the partner in the opposite manner as income or