gxpallsp.ppt - Partnership Operations Special Allocations...

Partnership Operations:
Special Allocations
© Copyright 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009 James Edward Maule
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Essentially, there is a general rule and 5 exceptions.
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As a practical matter, one looks to see if an exception
applies and resorts to general rule only if none of the
exceptions apply.
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The general rule ( §704(a)): “... partner’s distributive
share ... determined by the partnership agreement.”
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Exceptions:
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The substantial economic effect exception §704(b)
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The contributed property exception §704(c)
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Varying Interests §706(d)
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The “gift” partnership exception §704(e)
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The “nonpartner capacity” exception §707(a), (c)
Partnership Allocations: Overview

Unless the gift, contributed property, varying interests, or
partner noncapacity exception applies, p’ship items of
income, loss, gain, deduction, credit are allocated
pursuant to the partnership agreement. §704(a)
But if the allocation lacks substantial economic effect,
it is disregarded and the item is allocated in accordance
with the partner’s interest in p’ship §704(b)(2)
If there is no allocation in agreement, the item is allocated
in accordance with the partner’s interest in p’ship
§704(b)(1)
Special allocations: statutory construct

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Reg approach: is allocation valid?
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Allocation is valid if it meets one of these three:
1.704-1(b)(1)(i)
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Substantial economic effect 1.704-1(b)(2)
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In accordance with interests in p’ship 1.704-1(b)(3)
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Deemed to have substantial economic effect
1.704-1(b)(4)
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Reg structure
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1.704-1 (exc. for one rule in 1.704-2) [hereafter -1, -2]
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complexity and difficulties
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depth of subdivision via use of -1 and not -1 thru -n
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internal cross reference by long cite & not name
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layout/white space/margination
Special allocations: regulatory construct

(i) 2-prong definition (substantial economic effect
requires economic effect & substantiality)!
(ii) Economic effect
(a) Concept: tax allocation of item to partner who
bears actual economic burden or gets actual
economic benefit
(b) 3-prong mechanical test:
(1) capital accounts properly maintained
(per rules in -1(b)(2)(iv))
Special allocations: reg construct -1(b)(2)
(2) liquidations set to follow capital accounts
(3) obligation to restore deficits in capital accounts
. . . . . .
(e) allocation can have partial economic effect
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iv) Capital Account Accounting Rules (next slide)

Special allocations: reg construct -1(b)(2) (ct’d)
First, need to understand basics of
capital account accounting
Capital account is increased by
money contributed
FMV of property contributed
income and gain allocated to partner
Capital account is decreased by
money distributed
FMV of property distributed
loss and deduction allocated to partner
Note: FMV, not AB, of contributed/distributed property
Unaffected by share of partnership liabilities
Capital account can be negative
Hence, ABPI usually not the same as capital acct
So what does this mean?