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Taxation of Partnerships and Partners
Solutions to Problem Materials DISCUSSION QUESTIONS
22-1 The primary tax advantage of operating a business in partnership form is that business income is taxed only once to the partners. Business income earned by a corporation is subject to double taxation at both the corporate level and again at the shareholder level when the corporation pays a dividend or a shareholder sells stock at a gain. Under the rates currently in effect, the highest marginal rate for individual partners is only 35%, equal to the highest corporate rate of 35%. The disadvantages of operating in partnership form include general partners' unlimited liability for partnership debts (as contrasted to the limited liability of corporate shareholders) and the limited transferability of partnership interests (as contrasted to the free transferability of shares of corporate stock). (See pp. 22-2 through 22-4.) A general partner has the right to participate in the management of the partnership and make business decisions binding the partnership, while a limited partner may not participate in the operation and control of the partnership business. A general partner has unlimited personal liability for partnership debts, while a limited partner can only lose the amount of his capital investment in the partnership. General partners are subject to self-employment taxes, while a limited partner is not. (See p. 22-4.) Under the aggregate theory, a partnership is merely a collection of specific partners who each own an indirect interest in the assets of the partnership. Under the entity theory, the partnership is an entity with an identity separate and distinct from that of its partners. The fact that partnership income is taxed to the partners rather than the partnership reflects the aggregate theory. However, the fact that the character of that income is determined by reference to the partnership's activities reflects the entity theory. [See p. 22-4 and 701 and 702(b).] The statement is generally true. Section 721(a) provides that neither the partner nor partnership recognizes gain or loss upon the contribution of property by a partner in exchange for an interest in a partnership. The only exceptions to the nonrecognition rule apply to transfers of appreciated property with debt in excess of the property's adjusted basis and transfers of appreciated stocks or securities to investment partnerships. (See pp. 22-5 and 22-6.) Recourse partnership debt represents a liability that the general partners may have to repay out of their personal assets if the partnership itself is unable to make repayment. Because such debt is economically equivalent to an additional investment of capital by the general partners, it is included in the outside basis of their partnership interests. 22-2 22-3 22-4 22-5 22-1 22-2 Chapter 22 Taxation of Partnerships and Partners No partner is legally obligated to use personal assets to repay partnership nonrecourse debt. However, such debt will be repaid with income earned by the partnership and taxed to the partners. Therefore, both general and limited partners may include their apportionable share of such debt in their outside bases. (See pp. 22-6 through 22-10 and 752.) 22-6 A partner who contributes services in exchange for a capital interest in a partnership must recognize current compensation income equal to the fair market value of the interest received. A partner who contributes services in exchange for an interest in future partnership profits does not recognize income on the receipt of the interest, but only upon the allocation of future partnership income. (See Examples 10 and 11 and pp. 22-11 and 22-12.) Both partnership organization costs and syndication fees must be capitalized rather than deducted in the year incurred. However, the partnership may elect to deduct up to $5,000 of organization costs and to amortize the remaining costs over a 180-month period, beginning in the month in which business begins. (See p. 22-14 and 709.) A partnership may adopt any taxable year for which it can establish a business purpose to the satisfaction of the IRS. If no business purpose exists, the partnership is required to use the taxable year used by those partners who own more than a 50% interest in capital and profits. If no majority interest taxable year exists, the partnership must use the taxable year used by its principal partners (partners with at least a 5% interest in capital or profits). If the principal partners are on different taxable years, the partnership is required to use a taxable year that results in the least aggregate deferral of income at the partner level. The partnership also has the option of making a 444 election to use a taxable year other than its required year if such year results in no more than three months of deferral, but a noninterest-bearing deposit must be made with the IRS approximating the amount of tax deferred. [See Examples 12 and 13, pp. 22-13 and 22-14, and 706(b).] a. b. c. d. e. f. g. Increase Increase Decrease Decrease Decrease Decrease Increase 22-7 22-8 22-9 (See Example 16 and p. 22-17.) 22-10 A partner can lend money to or borrow money from a partnership, rent property to or from a partnership, buy property from or sell property to a partnership, or provide consulting services to a partnership as an independent contractor. These are examples of transactions that will be regarded as arm's length transactions between unrelated parties. This arm's length treatment reflects the entity theory of partnerships. [See pp. 22-24 and 22-25 and 707(a).] An individual who is a general partner is considered self-employed and therefore cannot be an employee of his or her own partnership. (See p. 22-22.) A current distribution is one that does not extinguish the recipient partner's interest in the distributing partnership. A liquidating distribution does extinguish the recipient partner's interest so that after the distribution the recipient is no longer a partner. (See p. 22-24.) The statement is true. Section 731(a)(2) provides for loss recognition only upon the receipt of a liquidating distribution. (See Examples 31 and 32 and pp. 22-25 and 22-26.) A partner will recognize capital loss if he receives a liquidating distribution consisting of only cash, inventory, and/or unrealized receivables, and the amount of cash plus the partnership basis in the inventory and receivables is less than the outside basis of the partnership interest. [See Examples 36 and 39, and pp. 22-27 through 22-31, and 731(a)(2).] 22-11 22-12 22-13 22-14 Solutions to Problem Materials 22-3 22-15 In order to determine the tax consequences of the liquidating distribution, Z must know the outside basis of his interest on April 3. This basis will be adjusted for Z's distributive share of partnership income or loss for the current year, and this share cannot be determined until after the December 31st close of the partnership taxable year. (See Examples 44 and 45, p. 22-32, and 705.) A payment made by a service partnership specifically for the recipient partner's interest in partnership goodwill is considered a liquidating distribution that can only result in the recognition of capital gain to the partner. On the other hand, a payment (1) made to a general partner of a partnership in which capital is not a material income-producing factor, and (2) which is not specified in the partnership agreement as a payment for goodwill, is a 736(a) payment representing ordinary income to the recipient. (See Example 47 and pp. 22-33 and 22-34.) The statement is true. Section 751(a) provides that to the extent that a partner receives money or property in exchange for all or part of his partnership interest that is attributable to hot assets, the gain or loss is ordinary income or loss. (See Example 55 and pp. 22-39 and 22-40.) The fact that 741 characterizes the gain or loss from the sale of an interest in a partnership with no hot assets as capital in nature reflects the entity theory of partnerships. Under this theory, the partner is selling an intangible ownership interest in a separate entity rather than an interest in the various assets owned by the entity. (See p. 22-38.) The purchase price of a partnership interest is determined with reference to the underlying value of the partnership assets, not to the assets' adjusted tax bases. Consequently, the outside cost basis of the interest will differ from the partner's proportionate share of the inside basis of partnership assets by the amount of the difference between the assets' aggregate basis and fair market value. This result reflects the entity theory of partnerships. (See Example 59 and pp. 22-41 and 22-42 and 742.) In a family partnership subject to the rules of 704(e), income must be allocated to reflect the value of services performed by any donor partner. Any remaining income must be allocated in the same proportion as the capital interests owned by the various family members. A family member cannot be a partner in a personal or professional service business unless he or she is capable of performing the type of services offered to the partnership's clientele. (See Examples 64 and 65 and pp. 22-44 and 22-45.) Because the death of a partner causes a closing of the partnership's tax year with respect to that partner, items of income, gain, loss, deduction, or credit attributable to the deceased partner's interest up to date of death (August 15) will be included on the final tax return of the decedent. Any amounts for the remainder of the partnership's tax year (August 16 through December 31) must be reported by the deceased partner's successor in interest. (See Example 66 and pp. 22-46 and 22-47). Dissolution of a partnership under state law occurs whenever a partner ceases to be associated with the active conduct of the partnership's business. Such legal dissolution is a pure reflection of the aggregate theory of partnerships. However, for tax purposes a partnership is not terminated unless it ceases to conduct any business in the partnership form (natural termination) or within a 12-month period there is a sale or exchange of 50% or more of the total interest in partnership capital and profits (technical termination). [See Example 67, pp. 22-47 and 22-48, and 708(b)(1).] 22-16 22-17 22-18 22-19 22-20 22-21 22-22 PROBLEMS
22-23 a. J has a $30,000 realized gain on the exchange of the land which is not recognized. G has a realized gain of $22,000 on the exchange of the inventory and a $4,000 realized loss on the exchange of the auto; neither gain nor loss is recognized. J has a substituted basis of $30,000 and G has a substituted basis of $42,000 in their partnership interests. The partnership has a carryover basis of $30,000 in the land, $28,000 in the inventory, and $14,000 in the auto. b. c. (See Example 2, pp. 22-5 and 22-6, and 721, 722, and 723.) 22-4 Chapter 22 Taxation of Partnerships and Partners 22-24 a. b. c. d. A recognizes no gain and takes a $5,000 basis in the partnership interest with a holding period of four years. The partnership's basis in the furniture is $5,000 with a holding period of four years. B recognizes no loss and takes a $12,000 basis in the partnership interest with a holding period of two years. The partnership's basis in the equipment is $12,000 with a holding period of two years. C recognizes no loss and takes a $9,000 basis in the partnership interest. C's holding period begins the day he acquires the interest. The partnership's basis in the inventory is $9,000 with a holding period beginning on the date of acquisition. D and E each take a $10,000 basis in their partnership interests with a holding period beginning on the date of acquisition. (See Example 2, pp. 22-5 through 22-6, and 721, 722, and 723.) 22-25 a. D recognizes no gain and takes a $10,200 initial basis in the partnership interest ($15,000 basis of land $4,800 net relief of 80% of the note payable) with a holding period of 10 months. The partnership's basis in the land is $15,000 with a holding period of 10 months. The outside bases of the other four partners will each increase by $1,200, their 20% share of the assumed note payable. Note that since each partner contributed $10,000 and all partners share losses equally, then under the constructive liquidation rules recourse debt is shared equally among the partners. E recognizes no gain and takes a $1,000 initial basis in the partnership interest [$5,000 basis of land $3,000 excess of nonrecourse debt over basis $1,000 share (20%) of remaining nonrecourse debt $8,000 relief of personal liability] with a holding period of three years. The partnership's basis in the land is $5,000 with a holding period of three years. The outside bases of the other four partners will each increase by $1,000, their 20% share of the assumed nonrecourse debt. b. (See Examples 5, 6, 7, 8 and 9, pp. 22-7 through 22-11 and 733 and 752.) 22-26 Since X and Y have made more than one contribution to Z partnership, their holding periods in their partnership interests will be divided based on the relative fair market values of the property contributed. X contributed cash of $50,000 on January 1, 2011 and land with a fair market value of $25,000 on July 1, 2011. The land had a holding period of six months and was an investment in the hands of X. Therefore his holding period at December 31, 2011 is: Cash contribution: $50,000/($50,000 $25,000) 66.67% Thus, for two-thirds of his interest his holding period is one year, since the cash was contributed on January 1, 2011 and has now been held for one year. Land contribution: $25,000/($50,000 $25,000) 33.33% Thus, for one-third of his interest his holding period is also one-year, but for a different reason. This portion of his interest received a holding period of six months from the land, and has now been held an additional six months by the partnership, for a total of one year. Y's holding period is computed as follows: Cash contribution: $50,000/($50,000 $15,000) 77% Thus, for 77% of her interest her holding period is one year, since the cash was contributed on January 1, 2011 and has now been held for one year. Land contribution: $15,000/($50,000 $15,000) 23% Thus, for 23% of her interest her holding period is determined by the holding period of the land. Since the land was inventory in the hands of Y, this portion of her interest does not receive a substituted holding period, and its holding period begins at the date of contribution. So her holding period for 23% of her interest is three months. (See Example 3 and p. 22-6.) Solutions to Problem Materials 22-5 22-27 If the assets were worthless and sold for no consideration, a $100,000 loss would be recognized. Only $10,000 of the loss can be allocated to L since she is a limited partner. The remaining $90,000 of loss is allocated to A and B based on their relative loss sharing ratios, as follows: A: $90,000 40% / (40% 35%) $48,000 B: $90,000 35% / (40% 35%) $42,000. After allocation of these losses, the capital accounts are as follows: A B Capital, 12/31 $ 20,000 $ 20,000 Loss allocation (48,000) (42,000) $(28,000) $(22,000) L $ 10,000 (10,000) $ 0 Therefore, A and B are allocated $28,000 and $22,000 of the recourse liability, respectively, while L is not allocated any of the liability. (See Example 6 and pp. 22-8 through 22-10.) 22-28 a. Corporation C must recognize a $61,000 gain and would have a basis of zero in the partnership. C's basis in the partnership (before recognition of gain by C) adjusted basis of property contributed by C ($320,000) liabilities assumed by the Beta Partnership ($635,000) C's share of partnership debt ($254,000; $635,000 * 40%) 61,000. The recognition of the $61,000 by C results in a basis in the partnership of zero. If the mortgage were nonrecourse, C would be allocated $443,000 of the mortgage for inclusion in its outside basis [$315,000 excess mortgage over contributed basis of land 40% of remaining mortgage ($320,000 40% $128,000)]. C would not recognize any gain because its $635,000 relief of debt is not in excess of its initial basis of $763,000 ($320,000 contributed basis of land $443,000 includible debt). Subsequent to this transaction, C's basis in its partnership interest is $128,000 ($763,000 $635,000). C's net relief of debt would be only $301,000 (60% net relief of the recourse mortgage $80,000 assumption of 40% of partnership's $200,000 other recourse liabilities). C would not recognize any gain and would have a $19,000 basis ($320,000 basis of contributed land $301,000 net relief of debt) in its partnership interest. b. c. (See Examples 7, 8 and 9, pp. 22-9 through 22-11, and 752.) 22-29 a. b. T must report income of $19,000 (20% of the $95,000 value of the partnership capital). T's basis in her partnership interest is $19,000. (See Example 10 and pp. 22-11 and 22-12.) 22-30 There is no partner, or group of partners, that has the same year-end and has a greater than 50% interest in the partnership. MN Partnership has three principal partners, but all the principal partners do not have the same year end. Therefore, the least aggregate deferral method must be used. The three months that must be tested are February, September, and December. Test of February 28 Year-End Partner F G H 11Test of September 30 Year-End Partner F G H Year-End 12/31 2/28 9/30 Profit Interest 30% 50% 20% Months of Deferral 3 5 0 Aggregate Deferral Weighted Deferral 0.9 2.5 0.0 3.4 Year-End 12/31 2/28 9/30 Profit Interest 30% 50% 20% Months of Deferral 10 0 7 Aggregate Deferral Weighted Deferral 3.0 0.0 1.4 4.4 22-6 Chapter 22 Taxation of Partnerships and Partners 11Test of December 31 Year-End Partner F G H 11The required year end is December 31 since it produces the least amount of deferral for the partners as a group. (See Example 13 and pp. 22-13 and 22-14.) 22-31 a. Gross receipts from sales Cost of sales Operating expenses 50% meals and entertainment Partnership taxable income $ 670,000 (500,000) (96,000) (3,350) $ 70,650 Year-End 12/31 2/28 9/30 Profit Interest 30% 50% 20% Months of Deferral 0 2 9 Aggregate Deferral Weighted Deferral 0.0 1.0 1.8 2.8 11b. Beginning outside basis Increase in share of partnership liabilities Distributive share of: Partnership taxable income Rental real estate income Dividend income Nondeductible meals and entertainment Section 1231 loss Ending outside basis 11-[See Examples 15 and 16, pp. 22-15 through 22-17, and 705(a).] 22-32 Sigma's $52,500 of organizational costs ($40,000 legal fee, $10,000 accounting fee, and $2,500 filing fee) and $18,000 of syndication fees (advertising and marketing expenses) must be capitalized. However, Sigma may elect to deduct up to $2,500 of the organizational expense and to amortize the remaining $50,000 over a 180-month period, beginning in the month the partnership begins business. Sigma cannot expense the full $5,000 allowed by the statute because its organizational expenses exceed $50,000 by $2,500. Therefore, the maximum deduction of $5,000 is reduced by this $2,500 excess, leaving an expense of $2,500. Consequently, Sigma may claim an amortization deduction of $556 ($50,000/180 months 2 months) on its first Form 1065. (See pp. 22-14 and 22-15, and 709.) a. The first year tax depreciation on the property is $11,200 (one-sixth of the property's $67,200 contributed basis). Noncontributing partner T should be allocated $10,000 of this depreciation (twothirds of the $15,000 depreciation calculated on the $90,000 value of the contributed property). Contributing partner S is allocated the remaining $1,200 of the tax depreciation. The gain recognized for book and tax purposes is computed as follows: Book $ 65,000 $ 90,000 (30,000) (60,000) $ 5,000 $ 67,200 (22,400) (44,800) $ 20,200 Tax $ 65,000 $125,000 5,500 7,065 4,800 1,000 (335) (1,350) $141,680 22-33 b. Amount realized Original basis Accumulated depreciation Adjusted basis Gain realized Solutions to Problem Materials 22-7 c. d. Noncontributing partner T would be allocated $3,333 (an amount equal to two-thirds of the book gain) of the $20,200 taxable gain and contributing partner S would be allocated the remaining $16,867 of the taxable gain. In this case, the partnership would recognize a $6,000 book loss and a $9,200 taxable gain on the sale. Because of the ceiling rule in the 704(c) regulations, only the actual taxable gain is subject to special allocation. Consequently, the entire $9,200 taxable gain is allocated to contributing partner S. The partnership would recognize a $20,000 book gain ($200,000 amount realized $180,000 contributed value) and a $55,000 taxable gain ($200,000 amount realized $145,000 contributed basis). Noncontributing partner S would be allocated $6,667 (one-third of the $20,000 book gain) and contributing partner T would be allocated the remaining $48,333 of the taxable gain. [See Examples 19 and 21, pp 22-19 through 22-20, and 704(c).] 22-34 a. b. c. As contributing partner, X would be allocated $30,000 of the gain ($25,000 precontribution gain one-third of the $15,000 remaining gain). The entire gain would be ordinary income. The character of the gain would be 1231 gain. If the selling price for the contributed inventory were only $100,000, the partnership would recognize a $45,000 book loss and a $20,000 ordinary tax loss. The noncontributing partners would be entitled to an allocation of $30,000 of tax loss (two-thirds of the book loss). However, because of the ceiling rule, they may only be allocated the entire $20,000 tax loss and X is allocated none of this loss. If Topper does not close its books on August 31, Corporation M may be allocated 100% of the operating loss and capital gain attributable to the portion of the year (122 days) during which the corporation was a partner. 122/365 $180,000 operating loss $60,164 122/365 $63,000 capital gain $21,058 b. If Topper does close its books on August 31, Corporation M may be allocated 100% of the $82,000 operating loss actually incurred during the portion of the year during which the corporation was a partner, and none of the capital gain incurred prior to the date it became a partner. 22-35 a. (See Example 22; pp. 22-20 and 22-21.) 22-36 Beginning outside basis Distributive share of: Dividend and interest income (60%) Capital gain (60%) Cash distribution a. Basis limitation on loss deduction Loss deduction (100%) Ending outside basis $ 100,000 8,760 37,200 (15,000) $ 130,960 (120,000) $10,960 b. 11- [See Example 23, p. 22-21, and 704(d).] 22-8 Chapter 22 Taxation of Partnerships and Partners 22-37 Beginning outside basis Distributive share of: Tax-exempt interest income (50%) Basis limitation on loss deduction Limited loss deduction* Ending outside basis $30,000 7,000 $37,000 (37,000) $ 0 *The deductible portions of Corporation Q's $53,000 distributive share of the partnership's ordinary loss and $21,000 distributive share of the partnership's capital loss are computed as follows: $53,000 ordinary loss $37,000 $26,500 ordinary loss $74,000 total losses $21,000 capital loss $37,000 $10,500 ordinary loss $74,000 total losses [See Example 24, p. 22-21 and Reg. 1.704-1(d)(2).] 1122-38 a. b. The partnership may not deduct the $4,000 December rent payment until the subsequent year in which the cash basis partner includes the rent payment in gross income. The partnership may deduct the $10,000 guaranteed payment in the current year in which it was accrued, and the partner must recognize the payment in the current year, which is the year with or within which the partnership year ends. (See footnote 58 and p. 22-22.) 22-39 a. b. c. B's total income is $62,500 [$50,000 guaranteed payment 50% of partnership taxable income of $25,000 ($75,000 $50,000 guaranteed payment)]. B's total income is $40,000 [$50,000 guaranteed payment 50% of partnership ordinary loss of $20,000 ($30,000 $50,000 guaranteed payment)]. B's total income is $62,500 [$50,000 guaranteed payment 50% of partnership ordinary loss of $25,000 ($25,000 ordinary income $50,000 guaranteed payment) 50% of $50,000 capital gain]. [See Examples 25 and 26, pp. 22-22 and 22-23, and 707(c).] 22-40 a. b. Because he owns more than a 50% interest in the purchasing partnership, V may not recognize his $1,000 realized loss. The partnership's cost basis in the land is $8,000. The partnership may deduct V's $1,000 disallowed loss against any gain realized on a subsequent sale of the land. The partnership's recognized gain (loss) on its subsequent sale of the land is (1) ($500), (2) 0-, and (3) $300. Because he does not own more than a 50% interest in the purchasing partnership, V may recognize his $1,000 realized loss. The partnership's cost basis in the land is $8,000. The partnership's recognized gain (loss) on its subsequent sale of the land is (1) ($500), (2) $600, and (3) $1,300. c. [See Example 28, p. 22-23, and 707(b).] 22-41 a. b. c. Corporation J must recognize a $125,000 capital gain. Even though Kappa is a controlled partnership, it is holding the land as a capital asset. Corporation J must recognize a $125,000 capital gain. In this case, Kappa is not a controlled partnership. Corporation J must recognize $125,000 as ordinary income on the sale because Kappa is a controlled partnership and does not hold the land as a capital asset [See Example 29, p. 22-26, and 707(b).] Solutions to Problem Materials 22-9 22-42 a. b. c. TUV's recognized gain is $5,000 ($15,000 $10,000). Since the computers were inventory in the hands of V, any gain recognized on the sale of the computers by the partnership for the next five years will be ordinary income. Therefore, TUV has $5,000 of ordinary income. Since there was a built-in gain of $6,000 in the inventory when contributed by V, the entire $5,000 ordinary income is allocated to V. TUV's recognized gain is $3,000 ($3,000 $0). Since the partnership has owned the inventory for more than five years, the rule from part a. does not apply. The gain is Section 1231 gain because the computers are depreciable property used in TUV's business. The $3,000 Section 1231 gain is allocated to V under the built-in gain rule. Answer is same as in part a. [See Examples 14 (p. 22-15) and 19 (p. 22-19), and Secs. 704(c) and 724(b).] 22-43 a. WXY has a recognized loss of $20,000 ($100,000 $120,000). The land was a capital asset in W's hands, and the land had a built-in loss of $20,000 when it was contributed to the partnership. Therefore, if the partnership sells the land during the next five years, the first $20,000 of loss will be a capital loss, regardless of how the partnership uses the property. The $20,000 loss is a capital loss, and it is allocated to W under the built-in loss rule. WXY has a recognized loss of $30,000 ($90,000 $120,000). Per the reasoning given in part a, $20,000 of loss is capital loss and is allocated to W. The other $10,000 of loss is ordinary since the partnership is a dealer in land. This loss is allocated $2,000 to W and $8,000 to the other partners. The rule given in part a does not apply since the land has been owned by the partnership for more than five years. The loss of $30,000 ($90,000 $120,000) is an ordinary loss. The first $20,000 of loss is allocated to W under the built-in loss rule, and the remaining loss is allocated $2,000 to W and $8,000 to the other partners. The partnership has ordinary income of $30,000 ($150,000 $120,000). $6,000 is allocated to W and the remaining $24,000 is allocated to the other partners. The built-in loss rule does not apply since the land was sold for a gain. b. c. d. [See Examples 14 (p. 22-15) and 20 (p. 22-20), and Secs. 704(c) and 724(c).] 22-44 a. b. c. $0. Although the distribution exceeds X's basis in her partnership interest on October 1, the regulations permit her to treat the distribution as if it occurred on the last day of the year. X's distributive share of partnership taxable income is $30,000 (50% $60,000), and her basis in her partnership interest is $25,000 ($10,000 $15,000 $30,000). If partnership taxable income had been $6,000, X would still recognize no income in October since the distributions are deemed to have occurred on the last day of the year. At the end of the year, X would have taxable income of $5,000 [$3,000 share of partnership income $2,000 capital gain ($10,000 $15,000 $3,000) since the cash distribution exceeds her basis in her partnership interest]. At the end of the year, her basis in her partnership interest is $0 ($10,000 $3,000 $2,000 $15,000). (See Example 30 and pp. 22-24 and 22-25.) 22-45 a. J does not recognize any gain on the distribution because the cash distributed does not exceed his basis in the partnership interest. The $20,000 partnership basis in the land will carry over to J, and he will have a $7,000 basis in his partnership interest after the distribution ($40,000 $13,000 cash received $20,000 carryover basis in the land). A partnership does not recognize gain or loss on the distribution of property to partners. J's $25,000 basis in his partnership interest is first reduced by the $13,000 cash distribution to $12,000. The $12,000 is the maximum amount that can be allocated as basis to the land. J's basis in his partnership interest after the distribution is zero. b. c. [See Examples 31 through 35; pp. 22-25 through 22-27; and 731, 732(a), and 733.] 22-46 a. b. c. Because C did not receive cash in excess of his outside basis, he recognizes no gain on the distribution. C's basis in the inventory will be $22,500 and his basis in his partnership interest will be zero. In this case, C would not recognize any gain on the distribution and would have a $25,000 carryover basis in the inventory and a $4,000 basis remaining in his partnership interest. [See Example 33, pp. 22-26 and 22-27, and 731, 732(a), and 733.] 22-10 Chapter 22 Taxation of Partnerships and Partners 22-47 a. b. If C sells the distributed inventory for $30,000 in the first year following its distribution by the partnership, he will recognize a $7,500 ordinary gain. If C waits for 6 years to sell the distributed inventory, the character of his $17,500 gain will depend upon the character of the inventory in C's hands. If he has held the inventory as an investment asset, he will recognize a capital gain. (See Example 48, p. 22-34, and 735.) 22-48 In the situation in problem 22-46(a), the partnership's $25,000 basis in the distributed inventory exceeded C's $22,500 postdistribution basis in the inventory. Consequently, the partnership may make a $2,500 positive adjustment to the basis of its remaining inventory. In problem 22-46(c), the $25,000 inside basis in the inventory carried over to C and no basis adjustment can be made by the partnership. [See Examples 49 and 50, pp. 22-35 through 22-37, and 734(b).] 22-49 R's outside basis is reduced by the basis of the property distributed, as follows: R's Basis $ 22,000 (10,000) $ 12,000 (4,000) $ 8,000 8,000 $ 0 Cash Accounts receivables and inventory Capital assets R has a basis of $0 in his partnership interest. R has a basis of $0 and $4,000, respectively, in the accounts receivable and inventory. However, the $8,000 basis for the capital assets must be pro-rated between the assets as follows: Inside Basis $5,000 8,000 Excess of Basis over Value $1,000 2,000 Basis Reduced by Excess $4,000 6,000 *Decrease Formula $ ,800 1,200 Capital asset 1 Capital asset 2 R's Basis $3,200 4,800 *Decrease Formula: Capital asset 1 [($4,000/$10,000) $2,000**] $ 800 Capital asset 2 [($6,000/$10,000) $2,000**] $1,200 **The $2,000 is the difference in the basis reduction needed of $8,000 and the total amount that the bases of Capital Assets 1 and 2 exceed fair market value ($4,000 $6,000 $10,000). [See Examples 33-35, pp. 22-25 through 22-27.] 22-50 a. F's $45,000 outside basis is first reduced by the $20,000 cash received. Her remaining $25,000 of outside basis is assigned to the one-half interests in the equipment and capital asset. Because the partnership's basis in these assets does not exceed (nor is less than) F's remaining $25,000, she will simply assign $20,000 of her basis to the equipment (1=2 of partnership's $40,000 basis) and the remaining $5,000 to the capital asset (1=2 of partnership's $10,000 basis). In this case, F's outside basis after reduction for the $20,000 cash distribution is $75,000. This basis is allocated between F's one-half interests in the equipment and capital assets under the basis increase formula since the sum of the carryover bases of the equipment and capital asset ($20,000 $5,000 $25,000) is less than F's $75,000 outside basis remaining. Because the $50,000 basis increase ($75,000 outside basis $25,000 carryover inside basis) exceeds the $25,000 sum of unrealized appreciation in the equipment ($15,000) and the capital asset ($10,000), the increase is first allocated between these assets to eliminate the relative unrealized appreciation. Following this first step, F's basis in the b. Solutions to Problem Materials 22-11 equipment becomes $35,000 (its fair market value) and her basis in the capital asset becomes $15,000 (its fair market value). Because F still has $25,000 of unassigned basis, this remainder is allocated between the assets based on relative fair market value. Thus the second step requires that an additional basis adjustment of $17,500 ($35,000/$50,000 $25,000) be assigned to the equipment, and an additional $7,500 ($15,000/$50,000 $25,000) be assigned to the capital asset. Thus after all adjustments, F's basis in the equipment becomes $52,500 ($20,000 carryover basis $15,000 $17,500) and her basis in the capital asset becomes $22,500 ($5,000 carryover basis $10,000 $7,500). [See Examples 38 through 43, pp. 22-28 through 22-31, and 731(a) and 732(b) and (c).] 22-51 Since this is a liquidating distribution, J's basis in her partnership interest must be zero after the distribution. Therefore, her $100,000 outside basis must be allocated to the distributed assets. The capital assets are first allocated the basis they have to the partnership, and then any assets that are appreciated receive any remaining allocation. Since Capital Asset 1 is the only appreciated asset, it receives the remaining allocation of $25,000, as follows: Inside Basis $25,000 50,000 Additional Basis $25,000 ,000 Capital asset 1 Capital asset 2 J's Basis $50,000 $50,000 [See Example 43, p. 22-31.] 22-52 a. b. F has a $3,000 loss (outside basis of $12,000 less cash distributed of $9,000). There must be a $3,000 reduction in the basis of the EFG's capital assets, as follows: Inside Basis $14,000 $10,000 Excess of Basis over Value $4,000 $2,000 *Decrease Formula $2,000 $1,000 Asset M Asset N EFG's Basis $12,000 $ 9,000 *$4,000/($4,000 $2,000) $3,000 $2,000 $2,000/($4,000 $2,000) $3,000 $1,000 [See Example 41, pp. 22-30 through 22-32.] 22-53 a. The liquidating distribution to R is $118,000, the $115,000 cash to be paid plus relief of $3,000 of partnership liabilities. Of this amount, $103,000 is attributable to the value of R's one-third interest in partnership assets. Therefore, the 736(b) property payment is $103,000 (87.3% the total payment), and the remaining $15,000 (12.7% of the total payment) is a 736(a) income payment. Because the 736(a) income payment is determined without reference to partnership income, it is treated as a guaranteed payment to R, taxable as ordinary income. The 736(b) property payment is a liquidating distribution, and its tax consequence is determined under 731. The 736(b) property payment received will exceed R's outside basis and will result in capital gain of $20,000 being recognized. The ongoing partnership will deduct the 736(a) income payment made to R as a guaranteed payment from the partnership. The 736(b) property payment will be a nondeductible reduction of R's capital interest in the partnership. b. [See Examples 46 and 47; pp. 22-32 through 22-34; and 736.) 22-54 The 754 election will have no effect until year 5 when liquidated partner R recognizes a $20,000 capital gain under 731(a)(1). The partnership may increase basis of its 1231 and capital assets by $20,000. Note that because the gain is capital in nature, the positive basis adjustment may only be allocated to 1231(b) and capital assets held by the partnership. [See Example 49 and Example 50, pp. 22-35 and 22-36, 734(b) and 755, and Reg. 1.755-1(b).] 22-12 Chapter 22 Taxation of Partnerships and Partners 22-55 a. b. c. At the date of sale, the partnership has no unrealized receivables and no substantially appreciated inventory. However, the potential depreciation recapture of $53,000 is treated as an unrealized receivable. R's share of this is $17,667, so R must recognize ordinary income of $17,667. The total amount realized by R on the sale of his interest is $118,000 ($115,000 cash received $3,000 relief of one-third of the partnership debt). R must recognize a total gain of $35,000, which is the excess of the $118,000 remaining amount realized over R's $83,000 outside basis in his interest. Therefore, he has $17,667 of ordinary income and $17,333 of capital gain. U's basis in his partnership interest is $118,000 ($115,000 cash paid liabilities assumed). If no 754 election is in effect, U will have an $83,000 inside basis (one-third of $249,000) in his onethird share of the partnership assets, and a $118,000 cost basis ($115,000 cash paid $3,000 liabilities assumed) in his partnership interest. [See Examples 59 and 60, pp. 22-41 through 22-43, and 743(a) and 751(a).] 22-56 Since the RST partnership has a 754 election in effect, U is entitled to a $35,000 743 basis adjustment (the excess of his $118,000 outside basis over the $83,000 inside basis of his one-third share of RST's assets). Note that his outside basis is computed as the $115,000 cash payment plus one-third of the partnership's debt. The 743 adjustment is allocated first to ordinary income property based on the allocations of income, gain, or loss that the transferee partner would receive from a hypothetical sale of all ordinary income assets. This amount is $2,333 as shown below: Allocation between Classes U's Allocable Share (33 %) Adjusted Basis $ 6,667 35,000 $41,667 Gain/ (Loss) $ (0) 2,333 $2,333 Ordinary Income Property Accounts receivable Inventory Total FMV $ 6,667 37,333 $44,000 The amount of the basis adjustment allocated to the capital gain property is the total adjustment reduced by the amount allocated to the ordinary income property, or $32,667 ($35,000 $2,333). Therefore, the 743 adjustment is allocated $2,333 to the ordinary income property and $32,667 to the capital gain property. Allocation within Classes If a hypothetical sale occurred of each item of ordinary income property, U would be allocated no gain or loss from the sale of the receivables and a gain of $2,333 from the sale of the inventory. Therefore, these amounts are the basis adjustments for these items of partnership property. If the 1231 asset was sold, U would be allocated a gain of $17,667 (1/3 ($57,000 $4,000), which is the basis adjustment for the 1231 property. The regulations under 755 also require that the remaining 743 adjustment of $15,000 be added to the capital gain property. [See Example 59, pp. 22-41 and 22-43, and Reg. 1.755-1(a)(1)(iv).] 22-57 a. Amount realized Adjusted basis Recognized gain/loss Total $ 50,000 (30,000) $ 20,000 Hot Assets (Sec. 751(a)) $13,000 (7,000) $ 6,000 Ordinary income Other (Sec. 741) $ 37,000 (23,000) $ 14,000 Capital gain 11b. c. D has a cost basis in her partnership interest of $50,000. If the partnership sells the land for $50,000, it will recognize a gain of $42,000 ($50,000 basis of $8,000). This $42,000 gain would be divided equally among D, U, and V. Thus, D would be allocated a gain of $14,000, even though D's purchase price of $50,000 reflected the full fair market value of the land. Solutions to Problem Materials 22-13 d. e. D should request that the partnership make a Section 754 election. The gain will still be $20,000 as computed in part a. However, the nature of this gain is different. T's share of the collectible's gain will be taxed to her at at 28% rate. If the collectibles were sold, T would be allocated $6,000 of the $18.000 gain, so $6,000 of the gain is taxed at 28%. If the building was sold by the partnership, the recognized gain would be $41,000 ($50,000 $9,000), $10,000 (excess depreciation over straight-line) of which would be recaptured as ordinary income under the 1250 recapture rules. Additionally, the unrecaptured depreciation ($20,000) is taxed at 25%. T's share of the ordinary income is $3,333 and of the 25% gain is $6,667. To summarize, her gain is taxed as follows: Recognized gain Collectibles gain (28%) Ordinary income recapture Unrecaptured Sec. 1250 gain (25%) Capital gain $20,000 (6,000) (3,333) (6,667) $ 4,000 11-(See Examples 56 and 57 and pp. 22-40 through 22-41.) 22-58 D is entitled to her basis adjustment for the difference in her outside basis in the partnership interest ($50,000) and her one-third share of the inside basis of the partnership assets, $30,000 ($90,000 1/3). The adjustment of $20,000 is allocated to the items based on the gain that would be allocated to D upon a hypothetical sale of these assets. The allocation to the inventory is $6,000 [1/3 ($39,000 $21,000)]. The allocation to the land is $14,000 [1/3 ($50,000 $8,000)]. (See Examples 57 and 58 and pp. 22-40 through 22-41.) 22-59 a. b. c. d. e. This is a nontaxable exchange. K will take a $37,000 basis in his new general partnership interest. This is a taxable exchange. K will recognize a $13,000 gain and take a $50,000 cost basis in the land. No gain will be recognized on K's final Form 1040 because of this disposition. Per 1014, K's nephew will take a $50,000 stepped-up basis in the interest. This is a taxable exchange since the requirements of 351(a) are not met (K does not own at least 80% of Gamma Inc. K will recognize a $13,000 gain and take a $50,000 cost basis in the Gamma stock. K can claim a $37,000 ordinary abandonment loss. (See Examples 64 through 66 and pp. 22-45 through 22-47.) 22-60 a. b. c. The sale generates a recognized loss of $600 ($800 $1,400). The built-in loss of $400 ($1,000 $1,400) is allocated to D. The remaining $200 loss is allocated equally to C and D. D's basis in his partnership interest is $1,400 (the same basis he had in the land). His recognized loss is $500 ($900 $1,400). Once D sells the property to E, 704(c)(1)(C) requires that in determining the amount of items allocated to other (non-contributing partners), the basis of the property is assumed to be its fair market value at the time of contribution. Therefore, when the property is sold, the basis used to compute the gain/loss is $1,000, the fair market value on the date of contribution. The recognized loss is then $200 ($800 $1,000) and it is shared between C and E. (See Example 63 and pp. 22-44 and 22-45.) 22-61 a. The March 31, 2012 sale by G of a 30% interest terminates the Beta Partnership. Two sales representing a cumulative 55% interest in Beta (A's sale of her 25% interest on June 8 and G's sale of his 30% interest) occurred within a 12-month period. Note that G's November 19 contribution of capital was not a sale or exchange and therefore did not trigger a technical termination. Beta's taxable year closes on March 31, 2012. b. [See Examples 67 and 68, pp. 22-47 and 22-48, and 708(b)(1).] ...
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This note was uploaded on 02/05/2012 for the course ACCT 110 taught by Professor Smith during the Spring '11 term at Adrian College.
- Spring '11