Lind Chapter 7 Solutions

Lind Chapter 7 Solutions - OPERATING DISIRIBLTYONS CB...

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Unformatted text preview: OPERATING DISIRIBLTYONS CB 308-313 One men must characterize A's $2,000 gain. Section 735(a)(1) is inapplicable because § 1245 recapture property is not an unrealized receivable for purposes of § 735. See § 751(c), the first clause of the last paragraph. Nevertheless, the partnership's recapture taint carries over to A. § 1245(b)(5)(A). In determining A's recomputed basis, § 1245(b)(5)(B)(i) requires the amount of recapture gain the partnership would have had if it had sold the taxi for its fair market value immediately before the distribution to be added to A's adjusted basis. If the partnership had sold the taxi, it would have had a § 1245 gain of $1,000 ($3,000 less $2,000). Thus on A's sale, the lesser of: the taxi's § 1245(b)(5)(B)(i) recomputed basis ($1,000 + $1,000): $2,000 or A's amount realized: $3,000 less his adjusted basis ($1,000) is his § 1245(a) recapture gain. A would have $2,000 less $1,000, or $1,000 of § 1245(a) ordinary gain. The remaining $1,000 would be either § 1231 or long—term capital gain. Page 308: Page 313: (a). For a thoughtful critique of § 734(b) basis adjustments and recommendations on how the system might be improved, see Abrams, "The Section 734(b) Basis Adjustment Needs Repair," 57 Tax Lawyer 343 (2004). Rev. Rul. 92-15, 1992-1 CB. 215, explains the effect of § 754 elections by tiered partnerships. In the ruling, both the upper-tier partnership ("UTP") and the lower-tier partnership ("LTP") have a § 754 election in effect. If UTP distributes property to a partner and the basis of its interest in LTP is adjusted under § 734(b), that adjustment is deemed to require LTP to adjust the basis of its property under § 734(b) by the same amount. The adjustment in LTP is personal to UTP. Alternatively, if UTP distributes its interest in LTP when both have § 754 elections in effect, and if § 732(a)(2) applies to the LTP interest, then UTP increases the basis of its undistributed property to the extent provided in § 734(b)(1)(B). For a critique of this ruling, see Pennell and Postlewaite, " Adjusting the Basis of Assets in Tiered Partnerships Under lRS‘ Questionable New Ruling," 77 J. Tax'n 4 (1992). PROBLEM Under § 73l(a)(1), A recognizes no gain on the distribution. A takes capital asset #1 with a $70,000 basis (limited by his outside basis) under § 732(a)(2), and reduces his outside basis to zero under § 733. The partnership recognizes no loss on the distribution because of § 731(b), and under § 734(a) it makes no adjustment to the bases in its assets. Its balance sheet after the distribution is: "law CB 313 CHAPTER SEVEN Assets Partners' Capital A.B. F.M.V. A.B. F.M.V. Cash $60,000 $ 60,000 A $ 0 $ 20,000 Cap. Asset #2 40,000 60,000 B 70,000 80,000 Cap. Asset #3 20,000 60,000 C 70,000 80,000 $ 120,000 180 000 $ 140,000 $ 180,000 The $20,000 imbalance is attributable to the fact that the distributed property "lost" $20,000 of its basis on the distribution. (b). The results to A are the same. Again, the partnership does not recognize its loss. However the § 754 election now triggers a § 734(b)(1)(B) upward adjustment of $20,000, equal to the property's downward change in basis: $90,000 (the distributed property's basis before the distribution) reduced by $70,000 (its basis after the distribution). The § 734(b) adjustment is allocated among the partnership assets by the § 755 rules. First, Reg. § 1.755-1(c)(1)(i) requires the § 734(b) adjustment to be allocated to property of the same character as the distributed property (i.e., capital assets and § 1231 property). The allocation within that class is first made to properties with unrealized appreciation in proportion to the appreciation in those properties. Reg. § 1.755—1(c)(2)(i). Since capital asset #2 has appreciated by $20,000 and capital asset #3 by $40,000, 20/60 or 1/3 of the adjustment ($6,667) is allocated to capital asset #2 and 40/60 or 2/3 of the adjustment ($13,333) is allocated to capital asset #3. Thus the inside basis of capital asset #2 is increased by 1/3 of $20,000 (the 734(b) adjustment) or $6,667 and the inside basis of capital asset #3 is increased by 2/3 of $20,000 of $13,333. The resulting "balanced" balance sheet is: Partners' Capital Assets A.B. F.M.V. A.B. F.M.V. Cash $ 60,000 $ 60,000 A 0 20,000 Cap. Asset #2 46,667 60,000 B 70,000 80,000 Cap. Asset #3 33,333 60,000 C 70,000 80,000 S 140,000 $ 180,000 140 000 S 180,000 (c). Since A's basis in the capital asset is limited to his outside basis of $70,000, $20,000 of basis is lost from capital asset #1 and added to capital asset #2 (1/3 of the increase) and capital asset #3 (2/3 of the increase). Absent any allocation of this basis increase among the partners, it would benefit A, B and C in proportion to their interests after the distribution. Inherent in capital asset #1 prior to the distribution is a $30,000 loss. This should be shared evenly (that is, each partner should end up with $10,000 of that deductible loss). When A receives the asset, he takes it with a basis of 102 OPERATING DISTRIBUTIONS CB 313-319 $70,000. When he sells it for its fair market value of $60,000, he will recognize a $10,000 loss. The remaining partners should each get credit for their $10,000 share of the total $30,000 loss which was inherent in the asset. Although there is no possibility of B and C deducting their share of the loss on capital asset #1, the inside basis step-up should be allocated $10,000 to each of them, so that at least they will recognize a total of $10,000 less capital gain when capital assets #2 and #3 are sold. Technically, the above allocation has no substantial economic effect under § 704(b), and it is not governed by § 704(c) since capital assets #2 and #3 were not contributed to the partnership. However, it is not motivated by tax avoidance, and failure to allow it would result in effectively shifting some of A's tax burden to B and C. As a result, the allocation should be respected. Page 3 18: PROBLEMS (a). (b) . (c). (d) . Under the "traditional method" of Reg. § 1.704-3(b), when the partnership sells property #1 for $10,000, A is required to recognize his $8,000 precontribution LTCG on the property. § 704(c)(1)(A). As a result, A's outside basis is increased to $10,000. § 705(a)(1)(A). The distribution triggers § 704(c)(1)(B). A recognizes the same amount of gain that he would have recognized if the property had been sold by the partnership and characterized by the partnership's gain on the sale. § 704(c)(1)(B)(i) and (ii). Cf. § 724. Thus, A recognizes $8,000 of LTCG. In addition, A's outside basis is increased to $10,000 and the basis of property #1 is increased to $10,000 prior to its distribution to C. § 704(c)(1)(B)(iii). This distribution brings § 737 into play. A contributed appreciated property and he receives other property in a distribution within seven years of his contribution. A must recognize gain equal to the lesser of (1) $8,000, the FMV of the distributed property ($10,000) reduced by A's outside basis ($2,000) or (2) $8,000, A's net precontribution gain -- i.e., the net gain A would recognize under § 704(c)(1)(B) if the property contributed within seven years of the distribution was distributed by the partnership to another partner. § 737(a) and (b). See problem (b), above. The character of A's $8,000 gain is determined by the character of the precontribution gain as in problem (b), above, so it is LTCG. § 737(a). As a result of the application of § 737, A‘s outside basis is increased to $10,000 immediately prior to the distribution (§737(c)(1)), he takes a $10,000 basis in the distributed property (§ 732(a)(1)), and assuming he is not liquidated out, his outside basis is reduced to zero. § 733. In addition, the partnership's basis in property #1 is increased to $10,000. §737(c)(2). This distribution involves a double whammy. First, § 704(c)(1)(B) applies to B because his contributed property is distributed to another partner within seven years of its contribution. B thus has $5,000 of LTCG, his outside basis oIS:'lnCIeanu‘1u°$N}00v,"nduV‘f/l‘ongNJ1177.1139._a_.$1n 000 basis nrior to its distribution to A. In addition, §737 is applicable to A since A contributed appreciated property and received other property in a distribution within seven 103 (g)- OPERATING DISTRIBUTIONS CB 319-327 again apply) with the result that the § 737(a)(2) amount and § 737(a) gain would be zero. The issue here is whether § 737 provides an exception to the recognition of gain where a partner who has contributed appreciated property to a partnership receives a distribution of other like-kind property within seven years of the contribution. The § 737 regulations provide that a distributee partner's net precontribution gain is determined without regard to § 704(c)(2) when property contributed by the distributee partner is not actually distributed to another partner in a distribution related to the § 737 distribution. Reg. § 1.737-1(c)(2)(v). Thus, A would be required to recognize $8,000 LTCG. Reg. § 1.737-1(d). Page 319: In Notice 2006— 14, 2006-1 CB. 498, the Treasury and the IRS. announced that they are conducting a study of the § 751(b) regulations and considering alternative approaches to achieving the statute’s approach with greater simplicity. For analysis of the issues posed by the Notice, see Kalinka, “Individuals and Passthrough Entities, Notice 2006—14 Would ‘Simplify’ the Accounting Rules for Disproportionate Distributions from a Partnership by Making Them More Complex,” 84 Taxes 13 (2006), and Burke, “Remedying Flaws in the Hot Asset Sale Approach,” 116 Tax Notes 279 (July 23, 2007). Page 327: PROBLEMS 1(a). The first issue is whether there is a disproportionate distribution triggering application of § 751(b). Not surprisingly, the answer is yes. Prior to the distribution, A had a $1,000 interest in the § 751 assets (the receivables) and, as a result of the distribution, he has $3,000 worth of § 751 assets, or $2,000 too many. Prior to the distribution he had a 1/3 interest in $15,000 of § 741 assets or $5,000, but afterwards his interest in them is only 1/5 of $15,000 or $3,000. Thus he actually receives $2,000 too few § 741 assets which are, therefore, the assets required to be distributed to him in a "phantom distribution." Phantom Distribution. In the absence of the specific designation of the properties received in the phantom distribution, the regulations assume that the distribution is pro rata among the assets within the distributed class. Reg. § 1 .75 1—1 (g) Example (4)(c). Since the partnership has $6,000 of cash and $9,000 of capital asset, the distribution will consist of 40% cash and 60% capital asset. A receives $2,000 of § 741 assets made up of 40% of cash or $800 and 60% of capital asset worth $1,200. The distributed capital asset would have a $400 basis to the partnership (1/3 of its value) which would transfer to A under § 732(a)(1). A's outside basis is reduced under § 733 by $1,200 ($800 plus $400) to $1,800 and his remaining interest in the partnership is worth $4,000 ($6,000 less $2,000). CB 327 CHAPTER SEVEN After the phantom distribution of $800 of cash and $1,200 of capital asset, the partnership balance sheet is as follows: Partners' Capital Assets A.B. F.M.V. A.B. F.M.V. Cash $ 5,200 $ 5,200 A 1,800 4,000 Acct. Rec. 0 3,000 B 3,000 6,000 Capital Asset 2,600 7,800 C 3,000 6,000 $ 7,800 $ 16,000 $ 7 800 $ 16,000 Constructive Sale or Exchange. The parties are now ready for the constructive sale or exchange. On the exchange A has $800 of capital gain on the capital asset ($1,200 less $400) and he acquires $2,000 of receivables with a $2,000 cost basis. In the same transaction the partiership (actually B and C, the other partners) sells $2,000 of receivables, recognizing $2,000 of ordinary income which is taxed $1,000 to B and $1,000 to C. This increases each of their outside bases to $4,000. §§ 702(a)(8); 705(a)(1)(A). On the transaction the partnership acquires the $800 of cash and a capital asset worth $1,200 with a $1,200 cost basis. After the application of § 751(b), the partnership balance sheet is as follows: Partners' Capital Assets A.B. F.M.V. A.B. F.M.V. Cash $ 6,000 $ 6,000 A 1,800 4,000 Acct. Rec. 0 1,000 B 4,000 6,000 Capital Asset 3,800 9,000 C 4,000 6,000 § 9,800 $ 16,000 $ 9,800 $ 16 000 Section 73] distribution. A now receives the nondisproportionate distribution of § 751 receivables worth $1,000 in a § 731 distribution. He takes those receivables with a zero transferred basis under § 732(a)(1). His remaining outside basis is $1,800 under § 733. His total basis in the purchased and distributed receivables is $2,000. Since he began with a $3,000 outside basis and recognized an $800 capital gain, his total outside basis for his partnership interest and basis in distributed assets should and does equal $3,800 ($1,800 plus $2,000). After the above transactions, the balance sheet of the partnership is as follows: Partners' Capital Assets A.B. F.M.V. A.B. F.M.V. Cash 3% 6,000 $ 6,000 A 1,800 3,000 Capital Asset 3,800 9,000 B 4,000 6,000 Q 4.9051; 519119., $_9,_8@ 15 000 w 15 000 106 l(b). 2(a). Assets Cash Land OPERATING DISIRIB UT I ONS CB 327 The $800 increase in the basis of the capital asset is the result of the deemed repurchase of $1,200 worth of that asset back from A for $1,200. Generally, when the partnership purchases an asset, there is no need to specially allocate the asset's basis among the partners. But here, only B and C are taxed on the purchase of the capital asset (i.e., they are taxed on the entire gain resulting from the sale or exchange of the receivables), so they should benefit from the stepped-up basis in the capital asset. On the other hand, there is no special provision which allows such an allocation here. Since the property is purchased by, and not contributed to, the partnership, § 704(c) does not apply. Although the allocation is not typical of a § 704(b) allocation, it nevertheless would appear to be condoned under § 704(c) principles by Reg. § 1.704-1(b)(5) Example (l4)(i). Section 751(b) again applies in this problem. First, note that the inventory is substantially appreciated. Prior to the distribution A has a 1/3 interest in the $36,000 worth of § 751 assets worth $12,000 and afterwards he has a 1/9 interest in § 751 assets worth $4,000 (1/9 of $36,000). Thus A receives $8,000 too few § 751 assets. Examined another way, A had a 1/3 interest in $72,000 worth of § 741 assets ($24,000) before the distribution, and he has § 741 interests worth $32,000 afterwards: $27,000 of cash and $5,000 of the partnership's § 741 assets (1/9 of $45,000, the value of the remaining cash and land). Thus A receives $8,000 too many § 741 assets and will receive $8,000 of § 751 assets on the phantom distribution. Phantom Distribution. As a result of the above computations, A receives $8,000 worth of inventory with a zero basis in a phantom distribution under § 75 l(b). After that distribution the balance sheet of the partnership is as follows: Partners' Capital A.B. F.M.V. A.B. F.M.V. $ 36,000 $ 36,000 $ 18,000 28,000 A Inventory 0 28,000 B 18,000 36,000 C 18,000 36,000 $ 54,000 $ 100,000 $ 54 000 18,000 36,000 $ 100 000 Constructive Sale or Exchange. On this constructive sale, A has $8,000 of ordinary income and receives $8,000 of cash (part of the cash he actually received). The partnership purchases inventory with a cost basis of $8,000. Since the inventory is purchased with cash, B and C (the remaining partners) recognize no gain. After the constructive sale, the partnership balance sheet is as follows: 107 ...
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This note was uploaded on 09/20/2011 for the course ACC 656 taught by Professor Harder during the Fall '10 term at UNC Greensboro.

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Lind Chapter 7 Solutions - OPERATING DISIRIBLTYONS CB...

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