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Unformatted text preview: OPERATING DISIRIBLTYONS CB 308313 One men must characterize A's $2,000 gain. Section 735(a)(1) is inapplicable
because Â§ 1245 recapture property is not an unrealized receivable for purposes
of Â§ 735. See Â§ 751(c), the ï¬rst clause of the last paragraph. Nevertheless,
the partnership's recapture taint carries over to A. Â§ 1245(b)(5)(A). In
determining A's recomputed basis, Â§ 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 Â§ 1245 gain of
$1,000 ($3,000 less $2,000). Thus on A's sale, the lesser of: the taxi's Â§ 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 Â§ 1245(a) recapture gain. A would have
$2,000 less $1,000, or $1,000 of Â§ 1245(a) ordinary gain. The remaining
$1,000 would be either Â§ 1231 or longâ€”term capital gain. Page 308: Page 313:
(a). For a thoughtful critique of Â§ 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. 9215, 19921 CB. 215, explains the effect of Â§ 754 elections by
tiered partnerships. In the ruling, both the uppertier partnership ("UTP") and
the lowertier partnership ("LTP") have a Â§ 754 election in effect. If UTP
distributes property to a partner and the basis of its interest in LTP is adjusted
under Â§ 734(b), that adjustment is deemed to require LTP to adjust the basis
of its property under Â§ 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 Â§ 754 elections in effect, and if Â§ 732(a)(2) applies to the LTP
interest, then UTP increases the basis of its undistributed property to the extent
provided in Â§ 734(b)(1)(B). For a critique of this ruling, see Pennell and
Postlewaite, " Adjusting the Basis of Assets in Tiered Partnerships Under lRSâ€˜
Questionable New Ruling," 77 J. Tax'n 4 (1992). PROBLEM Under Â§ 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 Â§ 732(a)(2),
and reduces his outside basis to zero under Â§ 733. The partnership recognizes no loss on the distribution because of Â§ 731(b), and
under Â§ 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 Â§ 754 election now triggers a Â§ 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 Â§ 734(b) adjustment is allocated among the partnership assets by the Â§ 755
rules. First, Reg. Â§ 1.7551(c)(1)(i) requires the Â§ 734(b) adjustment to be
allocated to property of the same character as the distributed property (i.e.,
capital assets and Â§ 1231 property). The allocation within that class is ï¬rst
made to properties with unrealized appreciation in proportion to the
appreciation in those properties. Reg. Â§ 1.755â€”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 beneï¬t 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 313319 $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 stepup 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
Â§ 704(b), and it is not governed by Â§ 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. Â§ 1.7043(b), when the partnership
sells property #1 for $10,000, A is required to recognize his $8,000
precontribution LTCG on the property. Â§ 704(c)(1)(A). As a result, A's
outside basis is increased to $10,000. Â§ 705(a)(1)(A). The distribution triggers Â§ 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.
Â§ 704(c)(1)(B)(i) and (ii). Cf. Â§ 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. Â§ 704(c)(1)(B)(iii). This distribution brings Â§ 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 Â§ 704(c)(1)(B) if the property contributed within seven
years of the distribution was distributed by the partnership to another partner.
Â§ 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. Â§ 737(a). As a result of the application of Â§ 737, Aâ€˜s
outside basis is increased to $10,000 immediately prior to the distribution
(Â§737(c)(1)), he takes a $10,000 basis in the distributed property (Â§ 732(a)(1)),
and assuming he is not liquidated out, his outside basis is reduced to zero.
Â§ 733. In addition, the partnership's basis in property #1 is increased to
$10,000. Â§737(c)(2). This distribution involves a double whammy. First, Â§ 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 $5,000 of LTCG, his outside basis
oIS:'lnCIeanuâ€˜1uÂ°$N}00v,"nduVâ€˜f/lâ€˜ongNJ1177.1139._a_.$1n 000 basis nrior to its
distribution to A. In addition, Â§737 is applicable to A since A contributed
appreciated property and received other property in a distribution within seven 103 (g) OPERATING DISTRIBUTIONS CB 319327
again apply) with the result that the Â§ 737(a)(2) amount and Â§ 737(a) gain
would be zero. The issue here is whether Â§ 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 likekind property within seven years of the
contribution. The Â§ 737 regulations provide that a distributee partner's net precontribution
gain is determined without regard to Â§ 704(c)(2) when property contributed by
the distributee partner is not actually distributed to another partner in a
distribution related to the Â§ 737 distribution. Reg. Â§ 1.7371(c)(2)(v). Thus,
A would be required to recognize $8,000 LTCG. Reg. Â§ 1.7371(d). Page 319: In Notice 2006â€” 14, 20061 CB. 498, the Treasury and the IRS. announced
that they are conducting a study of the Â§ 751(b) regulations and considering
alternative approaches to achieving the statuteâ€™s approach with greater
simplicity. For analysis of the issues posed by the Notice, see Kalinka,
â€œIndividuals and Passthrough Entities, Notice 2006â€”14 Would â€˜Simplifyâ€™ the
Accounting Rules for Disproportionate Distributions from a Partnership by
Making Them More Complex,â€ 84 Taxes 13 (2006), and Burke, â€œRemedying
Flaws in the Hot Asset Sale Approach,â€ 116 Tax Notes 279 (July 23, 2007). Page 327: PROBLEMS 1(a). The ï¬rst issue is whether there is a disproportionate distribution triggering
application of Â§ 751(b). Not surprisingly, the answer is yes. Prior to the
distribution, A had a $1,000 interest in the Â§ 751 assets (the receivables) and,
as a result of the distribution, he has $3,000 worth of Â§ 751 assets, or $2,000 too
many. Prior to the distribution he had a 1/3 interest in $15,000 of Â§ 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 Â§ 741 assets which are, therefore, the
assets required to be distributed to him in a "phantom distribution." Phantom Distribution. In the absence of the speciï¬c 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. Â§
1 .75 1â€”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 Â§ 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 Â§
732(a)(1). A's outside basis is reduced under Â§ 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. Â§Â§ 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 Â§ 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
Â§ 9,800 $ 16,000 $ 9,800 $ 16 000
Section 73] distribution. A now receives the nondisproportionate distribution
of Â§ 751 receivables worth $1,000 in a Â§ 731 distribution. He takes those
receivables with a zero transferred basis under Â§ 732(a)(1). His remaining
outside basis is $1,800 under Â§ 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,[email protected] 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 beneï¬t from the
steppedup 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, Â§ 704(c) does not apply. Although
the allocation is not typical of a Â§ 704(b) allocation, it nevertheless would
appear to be condoned under Â§ 704(c) principles by Reg. Â§ 1.7041(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 Â§ 751 assets worth $12,000 and afterwards he has a 1/9
interest in Â§ 751 assets worth $4,000 (1/9 of $36,000). Thus A receives $8,000
too few Â§ 751 assets. Examined another way, A had a 1/3 interest in $72,000
worth of Â§ 741 assets ($24,000) before the distribution, and he has Â§ 741
interests worth $32,000 afterwards: $27,000 of cash and $5,000 of the
partnership's Â§ 741 assets (1/9 of $45,000, the value of the remaining cash and
land). Thus A receives $8,000 too many Â§ 741 assets and will receive $8,000
of Â§ 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 Â§
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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