CHAPTER 11

PARTNERSHIPS AND LIMITED LIABILITY ENTITIES

SOLUTIONS TO PROBLEM MATERIALS

PROBLEM MATERIAL

1.

a

The entity probably is a partnership for tax purposes. In Hyman Podell, 55 TC 429 (1970), the court found that a partnership existed in similar circumstances. Although Dan does not exercise much managerial control over the day-to-day operations of the venture, he can help determine which real estate is purchased through the exercise of his veto power. If the intent of the partnership is to operate a real estate business, a partnership exists.

b

If Dan has no veto power and is merely guaranteed a 10% annual return, his

contribution to the venture appears to be more in the nature of a loan. If it is a loan, no partnership exists for tax purposes p. 11-4

2

a

Neither the partnership nor either of the partners recognizes any gain on formation of the entity, per § 721. p. 11-9

b

Larry will take a cash basis of $50,000 in his partnership interest. Example 7

c

Ken will take a substituted basis of $30,000 in his partnership interest ($30,000 basis in the property contributed to the entity). p. 11-8 and Example 8

d

The partnership will take a carryover basis in the assets it receives ($50,000 basis in cash, and $30,000 basis in property). p. 11-8 and Example 8

3

a

Lynn has a realized loss of $20,000. However, § 721 contains the general rule that no gain or loss is recognized to a partnership or any of its partners upon the contribution of money or other property in exchange for a capital interest. Since Lynn is subject to this rule, she does not recognize the loss. p. 10-9

b

$40,000. Section 722 provides that the basis of a partner’s interest acquired by a contribution of property, including money, is the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution.

c

$60,000, the adjusted basis of the contributed property (§ 722).

d

$60,000. Under § 723, the basis of property to the entity is the adjusted basis of such property to the contributing partner at the time of the contribution, increased by any § 721(b) gain recognized by such partner. Since no such gain (and no loss) was recognized by Lynn on the contribution, the partnership takes a carryover basis in the property. Example 14

e

A more efficient tax result may arise if Lynn sells the property to an unrelated

party for $40,000, recognizes the $20,000 loss on the property, and contributes $40,000 cash to the partnership. The partnership could then use the $40,000 to acquire similar property, in which it would take a $40,000 basis. Example 9

Concept Summary 10-1

4

a

Sylvia does not recognize the $5,000 realized loss on the land contribution. Section 721 applies to both the formation and later contributions of property

b

Sylvia's basis in her partnership interest is increased by $40,000 ($25,000 cash plus $15,000 land basis), to $90,000 ($50,000 initial basis plus $40,000 increase).

c

The partnership recognizes no gain or loss on this contribution

d

S & P takes a carryover basis of $15,000 in the land contributed by Sylvia.

e

When the partnership sells the land after 4 years, it recognizes a $7,000 loss ($15,000 basis - $8,000 selling price). Of this, $5,000 is a precontribution loss allocable to Sylvia. The land is a § 1231 asset to the partnership; however, it was a capital asset to Sylvia. The capital nature of the asset carries over to the partnership for the first five years the partnership owns the land to the extent of the built-in loss on the land at the contribution date ($5,000). Therefore, the first $5,000 of the loss is capital and is allocated to Sylvia. The remaining $2,000 is ordinary and is allocated to all the partners.

Examples 9, 10, and 16

13

a

Assuming that Earl’s capital account reflects an accurate number for basis purposes, the calculation is as follows:

Capital balance, beginning of year

$10,000 

Share of EZ's debt ($30,000 X 1/2)

 15,000 

Earl’s basis, beginning of year

$25,000 

b.

Capital balance, beginning of year

$10,000 

Add:

Taxable income

$4,000

Tax-exempt interest income

1,000

§ 1231 gain

3,000

Long-term capital gain

1,000 9,000 

$19,000 

Less:

Long-term capital loss

$ 60

Short-term capital loss

300

IRS penalty

315

Charitable contribution

100

Payment of Earl’s medical expenses

6,000

Cash distribution to Earl

14,000 (20,775)

($ 1,775)

Plus: Share of EZ’s debt ($40,000 X 1/2)

20,000 

Earl’s basis, end of year

$18,225 

16

a

Sales revenue

$130,000 

Cost of sales

(45,000)

Guaranteed payment to Kay

(24,000)

Depreciation expense

(12,500)

Utilities

(15,000)

Rent

(16,000)

Total ordinary income

$17,500 

Separately stated items:

Interest income

3,000 

Tax-exempt interest income

4,500 

Net long-term capital loss

(3,200)

The payment to Mount Vernon Hospital for Bob 's medical expenses is treated as a distribution to Bob in the amount of $10,000. Bob should determine whether or not he can claim a deduction for medical expenses on his personal tax return.

b

Bob 's basis in his partnership interest at the end of the tax year is determined as follows:

*These items are reported on Bob 's personal income tax return for the year. (The tax-exempt interest is only an information item on the personal return.)

c

Kay 's basis in her partnership interest at the end of the tax year is determined as follows.

Beginning basis

6,000   

Share of partnership income

8,750 *

Share of separately stated income items:

Interest income

1,500 *

Tax-exempt interest income

2,250 *

Long-term capital loss

(1,600)*

Ending basis in interest

16,900  

*These items are reported on Kay 's personal income tax return for the year. (The tax-exempt interest is only an information item on the personal return). In addition, Kay also reports ordinary income from the guaranteed payment in the amount of $24,000. Reporting the guaranteed payment as income does not increase Kay 's basis in her partnership interest.

The partnership deducts the guaranteed payment, which affects both partners' capital accounts equally.

17

a

The partnership's ordinary taxable income is determined as follows.

Sales revenue

Cost of sales

Guaranteed payment to Kay

Depreciation expense

Rent

Utilities

Total ordinary loss

Separately stated items remain as reported in Problem 16, with allocations to each partner as follows.

Total Amount

Amount for each partner

Interest income

$3,000 

$1,500

Tax-exempt interest income

4,500

2,250 

Long-term capital loss

(3,200)

(1,600)

The payment to Mount Vernon Hospital for Bob 's medical expenses is treated as a distribution to Bob in the amount of $10,000. Bob should determine whether or not he can claim a deduction for medical expenses on his personal tax return. Both partners must also consider whether the distributions they received are taxable.

b

Bob 's basis in his partnership interest at the end of the tax year is determined as follows, using the ordering rules of Figure 11-1

Beginning basis

$15,000 

Share of separately stated income items: Interest income

1,500 *

Tax-exempt interest income

2,250 *

Basis before loss allocations and distribution

$18,750 

Less: Distribution

(10,000)

Basis before loss allocation

$8,750 

Less: Loss allowed under § 704(d)

Net LTCL allocation:

$1,600 ÷ $12,850 X $8,750

(1,089)*

Ordinary loss allocation: $11,250 ÷ $12,850 X $8,750

(7,661)*

Ending basis in interest

$0

*As in Problem 16, Bob reports the interest income and tax-exempt income. His distribution from the partnership is not taxable since it is less than his basis after current income items. His net long-term capital loss and ordinary loss from the partnership, though, are limited under § 704(d). Of the $12,850 total losses, only $8,750 is deductible currently with the loss limitation allocated between capital loss and ordinary loss on a pro rata basis [Reg. § 1.704-1(d)(2)]. The remaining $511 net long-term capital loss and $3,589 ordinary loss are carried forward until such time as Bob has sufficient basis in his partnership interest to utilize the loss.

c

Kay 's basis in her partnership interest at the end of the tax year is determined as follows.

Beginning basis

Share of separately stated income items:

Capital gain on distribution in excess

of basis in partnership interest

* Kay reports the interest income and reflects this amount and the tax-exempt income in her basis for her partnership interest before considering either loss items or the distribution from the partnership interest. Since the distribution exceeds her basis in her partnership interest, the excess is taxable as a gain, and Kay 's basis is reduced to $0. Kay additionally will report as ordinary income the $24,000 guaranteed payment. (Her partnership interest basis is not increased by the guaranteed payment.)

Neither the net long-term capital loss nor the ordinary loss from the partnership is deductible under § 704(d). The $1,600 long-term capital loss and the $11,250 ordinary partnership loss are carried forward until such time as Kay has sufficient basis in her partnership interest to utilize the loss.

The partnership deducts the guaranteed payment, which affects both partners' capital accounts equally. pp. 11-29 and 11-30, Figure 11-1, and Examples 30 to 36

22

a

None. Section 721 contains the general rule that no gain or loss is recognized to a partnership or any of its partners upon the contribution of property in exchange for a capital interest in the partnership.

b

Adjusted basis of Lee's contributed property $15,000 

Less: Liability assumed by partnership (10,000)

Plus: Allocation of partnership liability to Lee ($10,000 X 25%) 2,500 

Adjusted basis of Lee's interest in LBR Partnership $ 7,500 

c

None. Section 721 applies to Brad's contribution

d

Adjusted basis of Brad's contributed property $16,000 

Plus: Allocation of partnership liability to Brad

($10,000 X 25%) 2,500 

Adjusted basis of Brad's interest in LBR Partnership $18,500 

e

Cash contributed by Rick $15,000 

Plus: Allocation of partnership liability to Rick

($10,000 X 50%) 5,000 

Adjusted basis of Rick's interest in LBR Partnership $20,000

f

$15,000. Section 723 states that the basis of property contributed to a partnership by a partner is the adjusted basis of such property to the contributing partner at the time of the contribution, increased by any § 721(b) gain recognized by such partner. Since no gain was recognized by Lee on the contribution, the partnership takes a carryover basis in the property.

g

$16,000. Section 723 applies

pp. 11-8, 11-9, and Example 26

23

a

Adjusted basis of Lee's contributed property

Less: Liability assumed by partnership (per § 752)

Plus: Allocation of nonrecourse debt for precontribution Liability in excess of basis ($20,000 - $15,000)

Plus: Allocation of remaining liability [($20,000 - $5,000) X 25%]

Adjusted basis of Lee's interest in the LBR partnership

b

Lee recognizes $0 gain on the contribution because the deemed $20,000 distribution does not exceed Lee's adjusted basis immediately before the distribution.

c

Adjusted basis of Brad's contributed property $16,000 

Adjusted basis of Brad's interest in LBR Partnership $19,750 

d

Cash contribution by Rick $15,000 

Adjusted basis of Rick's interest in LBR Partnership $22,500 

e

$15,000. Lee's basis in the contributed property.

27

a

In his June 30, 1999, tax return, Fred must report income from F & F of $70,000. This includes his $50,000 guaranteed payment, and his 50% distributive share of the partnership’s $40,000 of taxable income for the tax year ended December 31, 1998.

b

In her December 31, 1999, tax return, Fran must report income from F & F of $25,000. This is her 50% share of the partnership’s taxable income for the tax year ended December 31, 1999.

c

If Fred’s guaranteed payment increases to $60,000 on January 1, 1999, Fred’s income for his June 30, 1999, tax year would still be $70,000 (as in a., above). The salary increase will be reflected as a guaranteed payment on the K-1 issued for Fred for the partnership year ended December 31, 1999, and Fred will reflect this amount in his June 30, 2000, tax return.

28

a

Ned's distributive share of the partnership loss is $12,500. This amount is subject to the limitation imposed by § 704(d), so only $10,000 is currently deductible.

b

$25,000 [$35,000 as ordinary income (guaranteed payment) less Ned's $10,000 share of the partnership loss—subject to § 704(d)].

c

Ned's basis following the two transactions is $0.

Basis before current year activity $10,000 

Less: loss allocation allowed under § 704(d) (10,000)

Ending basis -0- 

The guaranteed payment does not directly affect Ned's basis, since it is not considered to be a distribution for basis purposes. Ned will carry the $2,500 unused loss forward until such time as he has adequate basis to permit a deduction.

29

a

Zero. Section 707(b)(1)(A) applies, and Anne's $50,000 realized loss is not deductible

b

$10,000. Section 267(d) permits the partnership to offset any subsequent gain by the loss previously disallowed ($60,000 gain less $50,000 previously disallowed loss).

c

Possibly zero. Anne's $80,000 gain would be ordinary under § 707(b)(2) if the investment property immediately after the transfer is not a capital asset of the Four Lakes Partnership.