Tax Chapter 20 No Homework-Forming and Operating Partnerships

March 25, 2018 | Author: Anjali Patel | Category: Partnership, S Corporation, Limited Liability Company, Tax Deduction, Taxes
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Chapter 20 - Forming and Operating PartnershipsChapter 20 Forming and Operating Partnerships SOLUTIONS MANUAL Discussion Questions 1. [LO 1] What is a flow-through entity, and what effect does this designation have on how business entities and their owners are taxed? Flow-through entities are entities that are not taxed on the entity level; rather, these entities are taxed on the owner’s level. These types of entities conduct a regular business; however, the income earned and deductions allowed are passed to the owners of these flow-through entities, and the owners are taxed on the amount allocated to them. Thus, flow-through entities provide a way for income and deductions to be taxed only once instead of twice. 2. [LO 1] What types of business entities are taxed as flow-through entities? The two main business entities that are taxed as flow-through entities are partnerships and S corporations. Partnerships are taxed under Subchapter K and consist of general partnerships, limited partnerships, and limited liability companies (LLC). S corporations are taxed under Subchapter S. Both these types of business entities are treated as flowthrough entities and are taxed accordingly. 3. [LO 1] Compare and contrast the aggregate and entity concepts for taxing partnerships and their partners. The aggregate concept treats partnerships more align with an individual. Each partnership is viewed as an aggregation of each partner’s separate interest in the assets and liabilities of the partnership. For example, each partner is proportioned and taxed on a certain amount of income the partnership creates. The partnership, as a whole, is never taxed. The entity concept treats partnerships more align with a corporation. Each partnership is an entity separate from its partners. For example, the partnership decides on which tax method to use and which tax elections to make, not the partners individually. 4. [LO 2] What is a partnership interest, and what specific economic rights or entitlements are included with it? 20-1 Chapter 20 - Forming and Operating Partnerships A partnership interest is an equity interest in a partnership. This interest is created through a transfer or sale of cash, property, or services in exchange for an equity interest in the partnership. A partnership interest gives each partner certain rights or entitlements. The two main economic rights are a capital interest and profit interest in the partnership. A capital interest is the right for a partner to receive a share of the partnership assets during liquidation. A profit interest is the right or obligation for a partner to receive a share of the future income or losses of the partnership. 5. [LO 2] What is the rationale for requiring partners to defer most gains and all losses when they contribute property to a partnership? The rationale for requiring partners to defer most gains and losses when contributing property to a partnership is twofold. First, the IRS desires that entrepreneurs have a way to start their own business without having to pay any taxes upfront. Second, the partners are considered still owning the property they have contributed to the partnership. While they don’t own the property outright, each partner has a small percentage of the property contributed in her/his partnership interest she/he exchanged for. This second reasoning helps further support the idea that partnerships follow the aggregate concept. 6. [LO 2] Under what circumstances is it possible for partners to recognize gain when contributing property to partnerships? Partners have the potential of recognizing gain on the contribution of property when the property contributed is secured by debt. In determining whether gain must be recognized, the partner must assess the cash deemed to have received from the partnership distribution compared with the tax basis of the partner’s partnership interest prior to the deemed distribution. If the cash deemed to have received exceeds the tax basis, then a gain must be recognized. This circumstance occurs due to the negative basis created for the partner, which is not allowed under partnership tax law. 7. [LO 2] What are inside basis and outside basis, and why are they relevant for taxing partnerships and partners? An inside basis, in relation to partnerships, is the basis the partnership takes in the assets that the partnership holds. An outside basis, in relation to partnerships, is the tax basis each partner has in the partnership. The inside basis is necessary to compute the gain/loss recognized on all property sold by the partnership. The outside basis is necessary to compute the gain/loss recognized on the partnership interest when sold. For tax purposes, the inside basis is similar to the basis the partner had in 20-2 Chapter 20 - Forming and Operating Partnerships the property prior to contribution. On the other hand, the outside basis corresponds not only to the contributed property, but also to the debt and income/losses of the partnership. 20-3 and what type of tax-related information does it provide? A tax-basis capital account is an equity account that is created for each partner of the partnership. [LO 2] What is a tax-basis capital account. Furthermore.Forming and Operating Partnerships 8. An example of recourse debt is accounts payable. This account is measured using the tax accounting rules. and how is each generally allocated to partners? Recourse debt is debt for which partners are considered to have an economic risk of loss. In calculating the outside basis of the partner.. if a partner acquires her/his interests by con- 20-4 .e. capital distributions. property and cash). The debt is allocated to the partners that have an economic risk of loss. Additionally. This is a debt for which partners are not legally liable for. If the partner is not allocated enough debt. [LO 2] What is recourse and nonrecourse debt. nonrecourse debt is allocated to all the partners according to the profit sharing ratios. For instance. the partner must take her/his tax basis in the property and decrease her/his basis by the amount of the property’s debt. a partner can only avoid gain by obtaining enough of the partnership debt to keep her/his basis at least above zero. This type of debt partners are legally liable for and must satisfy personally if the partnership cannot. a tax-basis capital account can provide more tax-related information for each partner. In regards to a partnership’s debt. Thus. An example of nonrecourse debt is a mortgage. and future earnings and losses allocated to that partner. the partner’s outside basis will become negative and a gain must be recognized. Nonrecourse debt is debt for which no partners are considered to have an economic risk of loss in. 10. each partner’s share of inside basis of the partnership’s assets can be calculated by adding the partner’s share of debt to her/his capital account. the property’s debt is allocated to each partner according to who is ultimately responsible for it or by each partner’s profit-sharing ratio. The account reflects tax basis of any capital contributions (i. [LO 2] How does the amount of debt allocated to a partner affect the amount of gain a partner recognizes when contributing property secured by debt? A partner that contributes property secured by debt is not only contributing the property to the partnership but also the debt. On the other hand. recourse debt is allocated to those partners that have the ultimate responsibility of paying the debt. Despite the partners not being legally liable for this debt. the debt is allocated proportionately to adjust the outside basis of each partner.Chapter 20 . Next. 9. Chapter 20 - Forming and Operating Partnerships tributing property tax-free, then the partner’s outside basis will be equal to that partner’s share of partnership inside basis. 20-5 Chapter 20 - Forming and Operating Partnerships 11. [LO 2] Distinguish between a capital interest and a profits interest, and explain how partners and partnerships treat when exchanging them for services provided. A partnership interest can be broken down into two distinct rights: (1) capital interest and (2) profits interest. To become a partner in a partnership, you will receive at least one of these rights. A capital interest is the right to receive a share of the partnership assets at liquidation. A profits interest is the right to share in the future earnings and losses of the partnership. While these rights are given to most partners that contribute cash or property, special rules exist when these rights are given to partners in exchange for services. When a partner receives a capital interest in exchange for services rendered to the partnership, the partner must treat the liquidation value of the capital interest as ordinary income. Further, the tax basis for the partner will be equivalent to the amount of ordinary income recognized. The holding period for this tax basis will begin on the date the capital interest is received. From the partnership’s perspective, the partnership can deduct or capitalize the value of the capital interest depending upon the type of services rendered. This is determined on a fact and circumstance basis. Additionally, the amount deducted by the partnership is allocated to the non-service partners as consideration for effectively transferring a portion of their capital interest to the service partner. When a partner receives a profit interest in exchange for services rendered to the partnership, the partner has no immediate tax impact because they have no liquidation value at the time they are received. Thus, the non-service partners will not receive any deductions for the additional partner to the partnership. As the partnership makes future profits and losses, the service partner will be allocated her/his portion of these losses according to the profit sharing ratios. The debt allocated to non-service partners must also be redistributed with the additional service partner receiving her/his portion of debt. Therefore, the tax basis of a service partner with only a profit interest will either be zero or the portion of debt the partner is allocated. 12. [LO 2] How do partners who purchase a partnership interest determine the tax basis and holding period of their partnership interests? When a partner purchases a partnership interest, the initial tax basis for the partner is a determined by taking the cost basis of the interest the partner purchased and adding to this basis any debt allocated to the partner’s interest. The holding period for this purchased interest will begin on the date that the partner purchased the partnership interest. 20-6 Chapter 20 - Forming and Operating Partnerships 13. [LO 3] Why do you think partnerships, rather than the individual partners, are responsible for making most of the tax elections related to the operation of the partnership? The responsibility for the partnership, not the partners, to make the majority of tax elections regarding the operation of the partnership is twofold. First, partnerships can consist of many different partners ranging from two to hundreds. The hassle to obtain every partner’s approval on what elections to make would be very time consuming. The costs would more than likely outweigh the benefits in performing this function. Second, in many partnerships only a few partners are actively involved in the management of the partnership. The limited partners have ownership to obtain a tax advantage on their own personal returns. Thus, the entity concept would appear more reasonable when dealing with the actual operations of the partnership. 14. [LO 3] If a partner with a taxable year-end of December 31 is in a partnership with a March 31 taxable year-end, how many months of deferral will the partner receive? Why? A partner with a calendar year end will receive nine months of deferral in her/his partnership interest that has a March 31 year end. A partner must report the income or loss of the partnership not at the partner’s year end but at the partnership’s year end. Thus, the first year of the partnership will be reported by the partner on her/his second return which includes the partnership’s year end. 15. [LO 3] In what situation will there be a common year-end for the principal partners when there is no majority interest taxable year? The principal partner test states that the required tax year is the taxable year all the principal partners have in common. A principal partner is a partner that owns at least 5 percent interest in the partnership profits and capital. For the principal partner test to pass and not the majority interest test, the partnership must consists of numerous partners that (1) own less than 5 percent profit and capital interest and (2) have a variety of fiscal year ends. For example, if four partners with a calendar year end owned 10 percent and 20 additional partners with differing fiscal year ends owned less than 5 percent, then the majority test would not pass, but the principal partners test would. 16. [LO 3] Explain the least aggregate deferral test for determining a partnership’s year end and discuss when it applies. The least aggregate deferral test is the last resort test that a partnership must follow when figuring out the partnership year end. The first test is the majority interest test. The second test is the principal partners test. 20-7 Chapter 20 . then the least aggregate deferral test goes into effect.Forming and Operating Partnerships If these two tests don’t apply. along with the exception to elect an alternative year end. 20-8 . 7. This is calculated by taking each partner’s months of deferral under the potential tax year and weighting it with the partner’s profit interest percentage. and why must they be separately stated to the partners? Separately-stated items must be taken out of ordinary income (loss) because these items either (1) relate only to a specific partner in the partnership or (2) the item is taxed differently for each partner depending upon the entity of the partner and the partner’s current tax situation. Then. 5. Short-term capital gains (losses) Long-term capital gains (losses) Section 1231 gains (losses) Charitable contributions Dividends Interest income Guaranteed payments Net earnings (losses) from self-employment 20-9 . Then. 3. Some of these items are considered to affect a specific partner or groups of partners differently.Forming and Operating Partnerships The least aggregate deferral test selects the tax year which provides the partner group as a whole the smallest amount of aggregate tax deferral. 1. 18. The total amount will be allocated to each partner according to the special allocation rules agreed upon or else based upon the profit sharing ratios of the partnership. The potential tax year that produces the smallest aggregate deferral must be the one chosen by the partnership.Chapter 20 . these separately-stated items must be reported on a partner-by-partner basis. partnerships create income or losses. unless the above exception applies. Under the tax accounting laws. 19. [LO 4] What is a partnership’s ordinary business income (loss) and how is it calculated? Through the course of business. 2. after adjusting the partnership’s business income (loss) for these separately-stated items. Thus. a partnership must use the accrual method of accounting with a corporate partner. 6. [LO 3] When are partnerships eligible to use the cash method of accounting? A partnership is eligible to use the cash method of accounting unless the partnership has average gross receipts over the past three taxable years greater than $5 million and has a corporate partner. 4. [LO 4] What are some common separately stated items. the partnership reports the remaining amount of business income (loss) to ordinary business income (loss). 8. The following is a list of items that are considered to be separately stated on a partnership return. each partner’s weighted totals are summed up to come up with an aggregate deferral number. 17. Tax-exempt income 10.Forming and Operating Partnerships 9. Investment interest expense 12.Chapter 20 . Net rental real estate income (loss) 11. Section 179 deductions 20-10 . On the partner level. Despite the chance that specific items would change character depending upon the partner who holds them. The partnership deducts the guaranteed payment in computing the partnership’s ordinary business income (loss). The idea behind a guaranteed payment is for a partner to receive a fixed amount of income no matter the profit (loss) for the partnership’s taxable year. 22. 21.Forming and Operating Partnerships 20. the partner must include the amount of the guaranteed payment in computing self-employment income for tax purposes. however. The limited partner’s share of ordinary business income is treated as investment income and not subject to self-employment tax. [LO 4] How do general and limited partners treat their share of ordinary business income for self-employment tax purposes? In determining how different partners treat their share of ordinary business income. partnerships are required to file a 1065 return along with all partners’ K-1s to help audit the amounts and character that show up on the individual partner’s return. General partners are considered to be actively involved in the management of the partnership. [LO 4] What are guaranteed payments and how do partnerships and partners treat them for income and self-employment tax purposes? Guaranteed payments are similar to cash salary payments for services provided. Thus. 20-11 . the general partner’s share of ordinary business income is treated as trade or business income and is subject to self-employment tax. limited partners are generally not actively involved with managing the partnership. on the partnership level. Conversely. they are treated like a salary payment to an unrelated party.Chapter 20 . [LO 4] Is the character of partnership income/gains and expenses/losses determined at the partnership or partner level? Why? In keeping with the entity concept. or LLC member. Further. Both types of partners must treat guaranteed payments as income relating to self-employment. the ordinary business income depends on the type of partner. the character of all income/gains and expenses/losses is determined at the partnership level. Thus. Thus. limited partner. the partner that receives a guaranteed payment must account for the guaranteed payment as a separately-stated item that is taxed as ordinary income. the IRS has decided to unify the character of all items by looking at the character from the partnership’s perspective. This amount is included no matter if the partner is a general partner. the IRS assesses the involvement the partner has in the partnership. Forming and Operating Partnerships 23.Chapter 20 . [LO 4] What challenges do LLCs face when deciding whether to treat their members’ shares of ordinary business income as self-employment income? 20-12 . Forming and Operating Partnerships Due to the lack of authoritative ruling that exists for LLCs. The regulation listed the following three criteria that would demonstrate active involvement in the LLC: (1) personally liable for the debt of the LLC as an LLC member. the IRS still requires all partnerships to file an information return to the IRS – Form 1065 (U. For example. While both of these items need to be met for a special allocation of a partnership item. This form must be filed by the 15th day of the 4th month of the partnership’s year end. Return of Partnership Income). 24. The proposed regulation helped clarify that if an LLC member is involved in the operations of the LLC. For calendar year end partnerships. members must decide on their own whether to include ordinary business income as self-employment income or not. then the LLC member would be more associated as a general partner and should more than likely account for the ordinary business income as self-employment income. An extension is available to file by the due date of the original return and provides the partnership 20-13 . the partnership will allocate according to the capital or profit interest.S. [LO4] What are the basic tax-filing requirements imposed on partnerships? While a partnership does not pay taxes. the form must be filed by April 15th. if the partnership has no mandatory allocations or does not specify and meet the requirements for special allocations. the member should treat the ordinary business income as self-employment income. however. [LO 4] How much flexibility do partnerships have in allocating partnership items to partners? Partnerships have a great deal of flexibility in determining how to allocate partnership items to partners. If any one of these requirements is met. or (3) participate in more than 500 hours in the LLC’s trade or business during the taxable year. A proposed regulation gave us clarity on this matter. Members of an LLC should still review this proposed regulation to understand the stance the IRS is trying to take and whether they will take an aggressive or conservative stance for their specific situation. contributed property builtin gain (loss) must be allocated to the partner who contributed the property when the property is sold. The second factor is put into place to make sure the allocations are being accomplished for a business objective and not just to reduce or avoid taxes. certain items have mandatory allocations to specific partners. Overall. Any additional gain (loss) will be allocated according to the partnership agreement. both separately-stated and non-separately stated items. 25. (2) authority to contract on behalf of the LLC.Chapter 20 . The determining factors must be (1) the partners agree upon the allocations and (2) the allocations have substantial economic effect. the regulation was withdrawn. Forming and Operating Partnerships an additional five months to file Form 1065. The extension must be filed on Form 7004.Chapter 20 . 20-14 . so these items will not ultimately be taxed or deducted at the time of selling a partnership interest or receiving a distribution from the partnership. In addition. These situations include when a partner sells her/his partnership interest or when a partner receives a distribution from the partnership. This schedule is an aggregate of each partner’s share of items both separately-stated and non-separately stated.Chapter 20 . and each individual partner will receive her/his own Schedule K-1 from the partnership. Partner’s share of ordinary business income 3. [LO 5] In what situations do partners need to know the tax basis in their partnership interests? Partners should always keep track of the tax basis in their partnership interest. 27. [LO 5] What items will increase a partner’s basis in her partnership interest? The following items will increase a partner’s basis and must be adjusted for on an annual basis in the order given. Schedule K must be filled out which lists the ordinary business income (loss) along with any separately-stated items. partners want to make sure they adjust for tax-exempt income and non-deductible expenses. however. 28. 26. Partner’s share of tax-exempt income 29. a partner does not want to double count any income/gain from the partnership when she/he sells her/his partnership interest or receive a distribution from the partnership. On page 3 of Form 1065. Second. certain situations require partners to actually know their tax basis. each partner’s proportion of the above items is reported on a Schedule K-1. [LO 5] What items will decrease a partner’s basis in her partnership interest? 20-15 . Last. the IRS does not want partners to double count any expenses/losses from the partnership in a similar situation from above. A Schedule K-1 for every partner must be filed with Form 1065. Actual and deemed cash contributions to the partnership 2.Forming and Operating Partnerships The tax return that must be filed by all partnerships consists of a detailed calculation of the partnerships ordinary business income (loss) on page 1 of Form 1065. 1. The main reasoning is to help the partner figure out the amount of gain which s/he most report on her/his current tax return. First. [LO 5] Why does a partner’s tax basis in her partnership need to be adjusted annually? A partner’s tax basis needs to be adjusted annually for the following three reasons. Partner’s share of separately-stated income/gain items and 4. penalties.Forming and Operating Partnerships The following items will decrease a partner’s basis and must be adjusted for on an annual basis in the order given. etc.) 3. Partner’s share of non-deductible expenses (fines. Actual and deemed cash distributions from the partnership 2. These items will be adjusted after all the increases to a partner’s basis have been taken into effect. 1. Partner’s share of separately-stated expenses/loss items 20-16 . Partner’s share of ordinary business losses and 4.Chapter 20 . The partner must overcome three loss limitation rules before the deduction is available. Second. and (3) the passive activity loss limitation. except for the share of nonrecourse debt attributable to the partner. If the loss does not pass any of the limitations. As a note. a partner cannot take any losses that exceed the at-risk limit for the partner. the partner’s outside basis. The three loss limitations are (1) assessing the tax basis of the partner. Passive losses. or (3) helping the partnership become more profitable. The at-risk limit is generally the same as the partner’s tax basis. 32. 20-17 . losses cannot be taken if the loss exceeds the amount of passive income reported by the partner. (2) guaranteeing more partnership debt. 31. (2) evaluating the at-risk loss limitation. Once the partner’s tax basis is positive. [LO 6] In what sense is the at-risk loss limitation rule more restrictive than the tax basis loss limitation rule? While the at-risk loss limitation and tax basis loss limitation are basically the same.Forming and Operating Partnerships 30. A partner would be able to increase her/his tax basis by (1) making a capital contribution. one difference exists between the two different hurdles a partner must overcome when faced with losses. The at-risk loss limitation only accounts for those items that the partner is at risk for. qualified nonrecourse debt is still considered to be part of the partner’s at-risk calculation. then the loss is suspended indefinitely under that specific hurdle. a partner is not able to take any losses that exceed the tax basis of the partner. the losses previously suspended can be used. This limitation prevents partners from taking losses beyond their investment or basis in their partnership interests. can only be offset with passive gains. [LO 6] What happens to partnership losses allocated to partners in excess of the tax basis in their partnership interests? Losses that are allocated to partners that exceed the partner’s tax basis cannot be used during the current taxable year.Chapter 20 . the individual partners potentially will not be able to deduct the entire amount in the year of the loss. First. The major item that is not included under the at-risk calculation but is included in the tax basis is nonrecourse debt. This limit still includes recourse debt and qualified nonrecourse debt. The excess loss will be suspended and carried forward indefinitely until the partner has sufficient basis to utilize the losses. losses from rental activities or limited partnerships. [LO 6] What hurdles (or limitations) must partners overcome before they can ultimately deduct partnership losses on their tax returns? While a partnership can create an ordinary business loss. Finally. Chapter 20 .Forming and Operating Partnerships 20-18 . regulations help clarify whether a partner would be considered a material participant. (2) at-risk loss limitation. As the losses exceed the limitation in each hurdle. tax basis of property contributed. [LO 6] In what order are the loss limitation rules applied to limit partner’s losses from partnerships? The order of the hurdles a partner must pass for the loss limitation rules are (1) tax basis loss limitation. a partner is considered to be a passive participant if the activity conducted is a trade or business and the partner does not materially participate in the activity. the partner can use the loss as a deduction on her/his own personal return. 35. 34. Further. items included in the at-risk amount would include cash contributed. and any other adjustments to the partner’s tax basis excluding nonrecourse debt. Nonrecourse debt is considered a part of the tax basis but not a part of the at-risk basis since the partner does not have an economic risk of loss for this type of debt. 20-19 . 3. the suspended losses will be carried forward indefinitely within each group until enough basis or income is generated to cover these losses. The individual’s activity constitutes substantially all of the participation in such activity by individuals.Chapter 20 . In most cases.Forming and Operating Partnerships 33. recourse debt. If the partner meets any of the conditions below. [LO 6] How do partners measure the amount they have at risk in the partnership? A partner will measure her/his partnership at-risk amount by looking at what items affect the partner’s economic risk of loss. 2. Once the loss has passed all three limitations. qualified nonrecourse debt. 1. The individual participates more than 100 hours during the year and the individual’s participation is not less than any other individual’s participation in the activity. The individual participates in the activity more than 500 hours during the year. then the partner would be a material participant and the activity would not be considered a passive activity to the partner. The IRS has made it clear that those participants in rental activities and limited partners within a partnership are automatically considered to be passive participants. [LO 6] How do partners determine whether they are passive participants in partnerships when applying the passive activity loss limitation rules? According to the Code. and (3) passive activity loss limitation. 20-20 . The activity qualifies as a “significant participation activity” (individual participates for more than 100 hours during the year) and the aggregate of all other “significant participation activities” is greater than 500 hours for the year.Chapter 20 .Forming and Operating Partnerships 4. law. First. The individual materially participated in the activity for any 5 of the preceding 10 taxable years.Forming and Operating Partnerships 5. 20-21 . 7. Taking into account all the facts and circumstances.e. and substantial basis during the year. and so on. 36. Second. a passive loss will not be deductible unless the taxpayer sells the activity that has produced the passive loss. Last. accounting. active income.Chapter 20 . a passive loss is not deductible until the taxpayer generates current year passive income from another passive activity the taxpayer is involved with. portfolio income. The activity involves personal services in health. the individual participates on a regular. In this case. or other passive income).. continuous. and the individual materially participated for any three preceding years. architecture. 6. the taxpayer will report a gain or loss on the sale and can use the passive loss to offset this or any other source of income ( i. [LO 6] Under what circumstances can partners with passive losses from partnerships deduct their passive losses? A partner may deduct the passive losses she/he has generated from a partnership under three circumstances. a passive loss is not deductible until the taxpayer generates current year passive income in the activity producing the loss. What is Berry Hill’s basis in the equipment? a. Because LLC general debt obligations are treated as nonrecourse debt. All capital or Section 1231 assets tacks onto the partnership interest. The basis in the equipment plus the basis in the cash will give us Berry Hill Partnership’s inside basis.000 to Berry Hill Partnership in exchange for a partnership interest. [LO 2] Joseph contributed $22. Joseph’s tax basis is considered to be his outside basis in the partnership.000. to Cloud Peak LLC in exchange for an 85 percent profits and capital interest in the LLC. Joseph’s holding period for his outside basis would depend upon the holding period of the assets contributed. What is Lance’s tax basis in his LLC interest? b.000 and a fair market value of $11. a.000 in cash and equipment with a tax basis of $5. Berry Hill Partnership’s basis in the equipment is a carryover basis from the partner who contributed the equipment. $455.000 share of the LLC debt (85% x $300. $5. The holding period for the equipment carries over to the Berry Hill Partnership from Joseph.000 in cash and his original basis in the equipment.000. What is Joseph’s tax basis in his partnership interest? b. 38.Chapter 20 .000. The tax basis includes the $22. What is Lance’s holding period in his interest? c.000. a. Lance’s basis in his LLC interest is made up of the $200.Forming and Operating Partnerships Problems 37. b. [ LO 2] Lance contributed investment property worth $500. Lance’s profit sharing ratio is used to allocate a portion of the LLC debt to him.000). All other property has a holding period from the date the partnership interest is acquired.000 to its suppliers but has no other debts. purchased three years ago for $200. $5.000 basis of the investment property he transferred to the LLC and his $255. What is Cloud Peak’s basis in the contributed property? d. What is Cloud Peak’s holding period in the contributed property? a. Cloud Peak owes $300.000. 20-22 . $27.000 cash. Forming and Operating Partnerships b.Chapter 20 . Three years. 20-23 . 000 $ 150. What is Harry’s tax basis in his partnership interest? 20-24 . 39. a. [LO 2] {Planning}Harry and Sally formed the Evergreen partnership by contributing the following assets in exchange for a 50 percent capital and profits interest in the partnership: Harry: Basis Fair Market Value Cash $ 30.000 120.Chapter 20 . What is Laurel’s initial tax basis in her LLC interest? b. What is Laurel’s holding period in her interest? c.000 $ 30.000.000 Land 100. Other than the accounts payable and mortgage. How much gain or loss will Harry recognize on the contribution? b. The LLC takes a carryover basis in the contributed property.000 150. purchased 10 months ago (acquired on January 31st) for $250. What is Sand Creek’s initial basis in the contributed property? d.000 Totals $ 130.000 a. How could the transaction be structured a different way to get a better result for Sally? d. Sand Creek does not owe any debts to other creditors. Laurel agreed to guarantee all $15.000 $ 150.000 of Sand Creek’s accounts payable but she did not guarantee any portion of the $100.000 nonrecourse mortgage securing Sand Creek’s office building. c. What is Sand Creek’s holding period in the contributed property? 40.000 Sally: Equipment used in a business 200. $200.Forming and Operating Partnerships Because Lance contributed a capital asset. the holding period of the contributed assets “tacks onto” his partnership interest. [ LO 2] Laurel contributed equipment worth $200.000.000 Totals $ 200. d. to Sand Creek LLC in exchange for a 15 percent profits and capital interest in the LLC. The LLC inherits Lance’s holding period in the contributed property. Three years.000 cash and used in her sole proprietorship. How much gain or loss will Sally recognize on the contribution? c. Generally. Partners may never recognize loss when property is contributed to a partnership even when they are relieved of debt. a. Harry’s basis in his partnership interest is simply the combined tax basis in the cash and land he contributed to the partnership. $0. she could recognize the $50.000. By selling the property. b.Forming and Operating Partnerships e. c. $130.Chapter 20 .000 built-in loss on the equipment. 20-25 . What is Evergreen’s tax basis in its assets? g. Harry did not have any debt relief. Sally should consider selling the property to the partnership rather than contributing it. partners recognize gain on property contributed to a partnership only when the cash they are deemed to receive from debt relief exceeds their basis in the partnership prior to the deemed distribution. $0. Prepare a tax basis balance sheet for the Evergreen partnership showing the tax capital accounts for the partners. d. What is Sally’s tax basis in her partnership interest? f. 000 of cash he is deemed to receive from debt relief does not exceed his basis in Y Mountain prior to this deemed distribution.Forming and Operating Partnerships e.000 41.000 $330.000 and a tax basis of $90.000 $330. [LO 2] Cosmo contributed land with a fair market value of $400.000).000 130. 20-26 . How much gain will Cosmo recognize from the contribution? b. The land is secured by $120.000.000).000 200.000 200. $330. $200.000. As reflected in the table below. The partnership’s tax basis balance sheet would appear as follows: Evergreen Partnership Tax Basis Balance Sheet Tax Basis Assets: Cash Equipment Land Totals Capital: Capital-Harry Capital-Sally Totals $30.000). The partnership’s basis in its assets equals the sum of the partners’ bases in the cash ($30. in the land ($100. a.Chapter 20 .000 to the Y Mountain partnership in exchange for a 25 percent profits and capital interest in the partnership. Cosmo does not recognize any gain because the $120. f.000 100. $0.000 of nonrecourse debt. What is Cosmo’s tax basis in his partnership interest? a. and in the equipment ($200. Y Mountain partnership does not have any debt. Other than this nonrecourse debt.000 basis in the equipment she contributed. g. Sally’s basis in her partnership interest equals $200. Chapter 20 . $22.000 $30.000 in cash.000) $22.000 Totals $ 120. Harold and Jenny each contributed $220.000Nonrecourse debt > basis is allocated only to Cosmo $22. 42. What is Maude’s tax basis in her LLC interest? c. [LO2] Maude. Prepare a tax basis balance sheet for the High Horizon LLC showing the tax capital accounts for the members.(2)] ($120. James.Forming and Operating Partnerships Description (1) Basis in contributed Land (2) Nonrecourse mortgage in excess of basis in contributed land (3) Remaining nonrecourse mortgage (4) Relief from mortgage debt Cosmo’s initial tax basis in Y Mountain Cosmo Explanation $90.50025% x [120.000 $ 220. What tax basis do James.000 200.000 James. How much gain or loss will Maude and the other members recognize? b. and Jenny have in their LLC interests? d.000 .500(1) + (2) + (3) + (4) b.500 as indicated in the table above.000 *Nonrecourse debt secured by the land equals $160. 20-27 . What is High Horizon’s tax basis in its assets? e.000 $ 20. Harold and Jenny formed the High Horizon LLC by contributing the following assets in exchange for 25 percent capital and profits interests in the LLC: Maude:Basis Fair Market Value Cash $ 20.$0. a. a. Harold.000 Land* 100. See table below: 20-28 .Chapter 20 .Forming and Operating Partnerships None of the partners recognize gain because their debt relief was not in excess of their bases in their partnership interest prior to any debt relief. 000 . above. High Horizon’s tax basis balance sheet would appear as follows: High Horizons. High Horizon takes a $120.(3)] d. LLC Tax Basis Balance Sheet Tax Basis Assets: Cash Land Totals $680.000 $60. See table in part a.000.000.000 carryover basis in the assets Maude contributes and a $660.000 each.000 to Maude 25% x [160.000 100.000 Other Members Explanation $20.000 Nonrecourse debt > basis is allocated only $25. above.Forming and Operating Partnerships Description (1) Basis in contributed Land (2) Cash contributed (3) Nonrecourse mortgage in excess of basis in contributed land (4) Remaining nonrecourse mortgage (5) Relief from mortgage debt Each member’s initial tax basis in the LLC b. $780. c.$45. Maude $100.000) $45.000 $245. $245.000 in the total cash the other three members contributed.000 ($160.000 780. See table in part a. e.000 (1) + (2) + (3) + (4) + (5) $25.000 $220.000 20-29 .Chapter 20 . how much gain or loss will Kevan recognize? g. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to guarantee 33. and Dave formed Albee LLC.000 $ 15.67 percent of the debt when Albee LLC was formed. How much gain or loss will Jerry. a.67 percent of the debt when Albee LLC was formed. What tax basis do Jerry and Dave have in their LLC interests? d.000 Land* 120. Jerry and Dave each contributed $245. Jerry.000) 220.000 *Nonrecourse debt secured by the land equals $210.000 Note that the members’ tax capital accounts are equal to their bases in the LLC interests less their individual shares of LLC debt. What is Albee LLC’s tax basis in its assets? e. Kevan contributed the following assets: Kevan: Basis Fair Market Value Cash $ 15. Dave and Kevan recognize on the contributions? b. What is Kevan’s tax basis in his LLC interest? c. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to guarantee 33.000 780.000 $ 245.000 220.33 percent of the debt and Jerry to guarantee the remaining 66.Forming and Operating Partnerships Liabilities and Capital: Mortgage debt Capital-Maude Capital-James Capital-Harold Capital-Jenny Totals 160.000 (40.000 230.33 percent of the debt and Jerry to guarantee the remaining 66.Chapter 20 .000 in cash. [LO2] Kevan. Prepare a tax basis balance sheet for the Albee LLC showing the tax capital accounts for the members.000 220.000 Totals $ 135. what are the members’ tax bases in their LLC interests? 20-30 . What is Kevan’s share of the LLC’s inside basis? f.000 Each member received a one-third capital and profits interest in the LLC. 43. 000 each. above.000 (1) + (2) + (3) + (4)+ (5) $40. Albee.000 $40. See table below: Description (1) Basis in contributed Land (2) Cash contributed (3) Nonrecourse mortgage in excess of basis in contributed land (4) Remaining nonrecourse mortgage (5) Relief from mortgage debt Each member’s initial tax basis in the LLC b.Forming and Operating Partnerships a.Chapter 20 .000 in the total cash the other two members contributed.000 Kevan $120.000 Nonrecourse debt > basis is allocated only to Kevan 33.000.3% x [$210. $0.000) $55. See table in part a. LLC takes a $135. $285.000 (3)] Other Members Explanation 20-31 .000 $285. c.000 $90.000 $245. above.000 $15.$55. ($210. d.000. None of the partners recognize gain because their debt relief was not in excess of their bases in their partnership interest prior to any debt relief. $625. See table in part a.000 carryover basis in the assets Kevan contributes and a $490. 000 Note that the members’ tax capital accounts are equal to their bases in the LLC interests less their individual shares of LLC debt.000 $033. LLC Tax Basis Balance Sheet Tax Basis Assets: Cash Land Totals Liabilities and Capital: Mortgage debt Capital-Kevan Capital-Jerry Capital-Dave Totals $505.000 (75.67% x $210.000 $15. Albee.Forming and Operating Partnerships e.000 $140.33% x $210.000 $70.000) 245.000 $245.000 Jerry Dave Explanation $245. f. LLC’s tax basis balance sheet would appear as follows: Albee . $5.000 for Kevan and 66.000) 20-32 .000 625.Chapter 20 .000. See table below: Description (1) Basis in contributed Land (2) Cash contributed (3) Mortgage Guarantee Kevan $120.000 for Jerry (4) Relief from mortgage debt ($210.000 245.000 120.000 625.000 210. According to Section 1245(b)(3). the annual depreciation calculation will proceed as if the property were still held by Jim. 20-33 . a. above.} b. What cost recovery method will Fast Choppers use to depreciate the machinery? {Hint: See § 168(i)(7). Because Jim was not relieved of any debt in the transaction.000 $0[(1)+ (2)+ (3) + (4)] $245. how much gain would Jim recognize and what is its character? {Hint: See § 1245 and 704(c).} a.} c.000.Forming and Operating Partnerships (5) Gain Recognized Each member’s initial tax basis in the LLC $5. Therefore. 44. Since then. Kevan’s basis is $0.Chapter 20 . he will not recognize gain from the contribution under Section 721. Jim does not recognize any of the Section 1245 recapture potential on the equipment at the time of contribution.000(1) + (2) + (3)+ (4) + (5) g. See the table in part f. Jerry’s basis is $385. According to Section 168(i)(7). b. and Dave’s basis is $245.000 cash for the equipment. In this situation. In other words. If Fast Choppers were to immediately sell the equipment Jim contributed for $150. and the fair market value of the equipment is now $150. Fast Choppers will continue to depreciate the equipment using the same method instituted by Jim over the remaining useful life of the equipment. recapture potential on property contributed to a partnership is only recognized to the extent any gain is recognized from the contribution of property.000.000 $0 $0 $385.000.000 because of tax depreciation. [LO2] {Research} Jim has decided to contribute some equipment he previously used in his sole proprietorship in exchange for a 10 percent profits and capital interest in Fast Choppers LLC. a transferee partnership will step into the shoes of the transferor partner for purposes of depreciating contributed equipment. Must Jim recognize any of the potential § 1245 recapture when he contributes the machinery to Fast Choppers? {Hint: See § 1245(b)(3). the tax basis in the equipment has been reduced to $100.000. Jim originally paid $200. all $50. as a result.000 loss characterized as a capital rather than an ordinary loss. c. Mountainside Developers will recognize a $50.Forming and Operating Partnerships c. [LO2] {Research} Ansel purchased raw land three years ago for $200. 45.000 to develop into lots and sell to individuals planning to build their dream homes. Thus. Moreover. the Section 1245 recapture potential remains with the equipment after the contribution.000. he decided to contribute it to South Peak In- 20-34 .} b.000 loss from the sale of the land.000 gain recognized or the $100.000 ordinary loss per Section 724(c). a. [LO2] {Research} Claude purchased raw land three years ago for $1. and the remaining $25. b. Mountainside Developers will recognize a $75.000 loss will be characterized as an ordinary loss per Section 724(c). In this instance. If Mountainside sells the property for $125. how much gain or loss is recognized and what is the character of the gain or loss? a. recognized losses on assets that were capital assets in the hands of contributing partners are treated as capital losses up to the amount of loss built into the assets at the time they were contributed if they are sold within a five year period beginning on the date of contribution. he decided to contribute it to Mountainside Developers LLC in exchange for a 5 percent capital and profits interest.Chapter 20 . how much gain or loss does it recognize and what is the character of its gain or loss? {Hint: See §724. how much gain or loss does it recognize and what is the character of the gain or loss? c. After watching the value of the land drop to $150.000 will be characterized as a capital loss.000 of gain recognized (the lesser of the $50. like his other development properties.000 depreciation taken) must be characterized as Section 1245 recapture income. Under Section 704(c). like all of the other real estate it holds.000 after holding it six years. Before completing the development of the property.000 after holding it for one year.000 to hold as an investment.000 of gain recognized from the sale of the equipment would be allocated to Jim because this gain was builtin at the time the equipment was contributed. Claude intended to treat this property as inventory. Mountainside plans to develop the property and will treat it as inventory. If Mountainside sells the property for $150. According to Section 724(c). The built-in loss at the time the land was contributed or $50. it will recognize a $50.500. If Mountainside sells the property for $150. however. 46. all $50.000 after holding it for two years. Because Mountainside Developers held the land as inventory for more than five years. 20-35 .Chapter 20 . South Peak’s strategy is to hold land for investment purposes only and then sell it later at a gain.Forming and Operating Partnerships vestors LLC when it was worth $2. in exchange for a 10 percent capital and profits interest.500.000. Because South Peak sold the land after the expiration of this time period and held the land as investment property. how much gain or loss is recognized and what is its character? {Hint: See § 724. Under Section 724(b). [LO2] {Research} Reggie contributed $10. how much gain or loss is recognized and what is its character? a.Forming and Operating Partnerships a. If Reggie sells his LLC interest thirteen months later for $30.000.000. how much gain does he report and what is its character? {Hint: See Reg.000 and tax basis of $10. a.000 when the tax basis in his partnership interest is still $20. Section 724(b) only applies if contributed property is sold during the five year period beginning on the date of contribution.000 four years after Claude’s contribution. the entire $1.000 when the tax basis in his partnership interest is still $20.500.000 gain from the sale of the land will be treated as ordinary gain.000.000 for a 5 percent capital and profits interest in Green Valley LLC.} b. it should recognize $1.000 five and one-half years after Claude’s contribution. any gain or loss on contributed property that was treated as inventory by the contributing partner and sold by the partnership during the five year period beginning on the date of contribution is treated as ordinary gain or loss. b. If South Peak sells the property for $3. If Reggie sells his LLC interest two months later for $30.1223-3} 20-36 . §1.000 of capital gain. Thus. If South Peak sells the property for $3.000.500. 47. how much gain does he report and what is its character? b.000 in cash and a capital asset he had held for three years with a fair market value of $20.Chapter 20 . 000. If Connie receives a 5 percent profits interest only.000. how much income must she report and what is her tax basis in the LLC interest? a.Forming and Operating Partnerships 48. Her basis in the LLC is $12. Connie will not report any income but will have a basis in the LLC interest equal to her share of the LLC’s debt.500 share of the LLC’s nonrecourse accounts payable. Her basis in the LLC interest is also $10. it must be allocated to her using Connie’s profits interest. Connie reports $10. If Connie receives a 5 percent capital and profits interest.Chapter 20 .000. For the current year. Connie reports $10. b. Kari’s interest will not be subject to a substantial risk of forfeiture and the costs for the type of services she provided are typically not capitalized by the partnership.500 or 5 percent of the LLC’s $50. If Connie receives a 5 percent capital interest only. Because the LLC’s debt is a nonrecourse debt. her basis in the LLC equals $2. [LO2] Connie recently provided legal services to the Winterhaven LLC and received a 5 percent interest in the LLC as compensation. how much income must she report and what is her tax basis in the LLC interest? b.000 of ordinary income or 5 percent of the LLC’s capital of $200.000 of income she recognizes for the receipt of her capital interest and her $2. how much income must she report and what is her tax basis in the LLC interest? c. 49. The current fair market value of Winterhaven’s capital is $200.000 accounts payable. c. 20-37 .000 of accounts payable and no other debt.000 of ordinary income or 5 percent of the LLC’s capital of $200.500 consisting of the $10. [LO2] Mary and Scott formed a partnership that maintains its records on a calendar-year basis.000. Kari will receive a one-third capital interest only in exchange for services rendered. the income and expenses from operations are equal. The balance sheet of the MS Partnership at year-end is as follows: Cash Land Inventory Mary Scott Basis $ 60 60 72 $192 $ 96 96 $192 Fair Market Value $ 60 180 60 $300 $150 150 $300 At the end of the current year. Winterhaven currently has $50. a. Thus. 20-38 .Chapter 20 . the only tax consequences for the year are those relating to the admission of Kari to the partnership.Forming and Operating Partnerships Consequently. Chapter 20 - Forming and Operating Partnerships a. Compute and characterize any gain or loss Kari may have to recognize as a result of her admission to the partnership. b. Compute Kari’s basis in her partnership interest. c. Prepare a balance sheet of the partnership immediately after Kari’s admission showing the partners’ tax capital accounts and capital accounts stated at fair market value. d. Calculate how much gain or loss Kari would have to recognize if, instead of a capital interest, she only received a profits interest. a. Kari will recognize one-third of the fair market value of the partnership’s capital or $100 as ordinary income. b. Kari’s basis in her partnership interest will be equal to the amount of income she reports or $100. c. Immediately after Kari’s admission into the partnership the partnership’s balance sheet will appear as follows: MS Partnership Balance Sheet Tax Basis Assets: Cash Land Inventory Totals Capital: Capital-Mary Capital-Scott Capital-Kari Totals $60 60 72 $192 46 46 100 $192 704(b)/FMV 60 180 60 300 100 100 100 $300 Essentially, the tax capital and 704(b) capital accounts for both Scott and Mary are reduced by their $50 share of the $100 compensation expense the partnership will deduct for the capital interest Kari receives. 20-39 Chapter 20 - Forming and Operating Partnerships d. If Kari only receives a profits interest, she will not recognize any income until she receives a profits allocation from the partnership. 50. [LO2] Dave LaCroix recently received a 10 percent capital and profits interest in Cirque Capital LLC in exchange for consulting services he provided. If Cirque Capital had paid an outsider to provide the advice, it would have deducted the payment as compensation expense. Cirque Capital’s balance sheet on the day Dave received his capital interest appears below: Assets: Basis Cash $ 150,000 $ 150,000 Investments 200,000 700,000 Land 150,000 250,000 Totals $ 500,000 $1,100,000 Fair Market Value Liabilities and capital: Nonrecourse Debt 100,000 100,000 Lance* 200,000 500,000 Robert* 200,000 500,000 Totals $ 500,000 $ 1,100,000 *Assume that Lance’s basis and Robert’s basis in their LLC interests equal their tax basis capital accounts. a. Compute and characterize any gain or loss Dave may have to recognize as a result of his admission to Cirque Capital. b. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt of his interest. c. Prepare a balance sheet for Cirque Capital immediately after Dave’s admission showing the members’ tax capital accounts and their capital accounts stated at fair market value. d. Compute and characterize any gain or loss Dave may have to recognize as a result of his admission to Cirque Capital if he receives only a profits interest. e. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt of his interest if Dave only receives a profits interest. a. The tax consequences of giving Dave both a 10 percent capital and profits interest are summarized in the following table: 20-40 Chapter 20 - Forming and Operating Partnerships Description (1) Beginning Basis in LLC Dave Lance $0 $250,000 Robert Explanation $250,000$200,000 tax basis capital account + [.5 x $100,000 nonrecourse debt] Liquidation Value of Capital Interest (.1 x $1,000,000 fair market value of LLC capital) ($50,000)Capital Shift from Non-Service Partners. (2) x .5 [$100,000 nonrecourse debt x 10% profit sharing ratio] (5,000) (2) Ordinary In- $100,000 come (3) Ordinary Deduction (4) Increase in Debt Allocation (5) Decrease in (5,000) $10,000 ($50,000) (4) x .5 Debt Allocation (6) Ending Ba- $110,000 $195,000 sis in LLC $195,000 (1) + (2) + (3) + (4) + (5) As indicated in line (2) of the table above, Dave recognizes $100,000 of ordinary income. b. As indicated in line (6) of the table above, the member’s tax bases in the LLC interests immediately after Dave is admitted are as follows: $110,000 for Dave and $195,000 for Lance and Robert. c. Immediately after Dave’s admission into the LLC, the LLC’s balance sheet will appear as follows: Cirque, LLC Balance Sheet Tax Basis Assets: Cash Land Inventory Totals $150,000 200,000 150,000 $500,000 704(b/)FMV $150,000 700,000 250,000 $1,100,000 20-41 000 $1.Forming and Operating Partnerships Capital: Nonrecourse Debt Capital-Lance Capital-Robert Capital-Dave Totals $100.000 100.000 100.Chapter 20 .000 $500.000 d. The tax consequences of giving Dave only a 10 percent profits interest are summarized in the following table: 20-42 .000 150.000 100.000 450.000 450.100.000 150. 000. and Robert’s basis is $245. What is Garrett’s tax basis in his partnership interest? b.000 (1) + (2) + (3) + (4) Dave does not recognize any income because he only received a profits interest. 51. [$100.000 tax basis capital account + [.000 Robert Explanation $250.5 x $100. Lance’s basis is $245. Prior to selling his interest.000 $245.000 $245. Ramon sold the 10 percent interest in the Del Sol Partnership that he had held for two years to Garrett for $400.5 $10. [LO 2] Last December 31. a.Forming and Operating Partnerships Description (1) Beginning Basis in LLC (2) Ordinary Income Dave Lance $0 $250.000.Chapter 20 .000) (3) x . As reflected in line (5) of the table above.000 (5.000) $0 (3) Increase in Debt Allocation (4) Decrease in Debt Allocation (5) Ending Basis in LLC $10. what is the character of his gain? 20-43 .000.000 which included a $100.000$200. Ramon’s basis in Del Sol was $200.000 nonrecourse debt] Dave does not recognize any income because he only receives a profits interest. Dave’s basis is $10. If Garrett sells his partnership interests three months after receiving it and recognizes a gain.000 share of nonrecourse debt allocated to him. e.000.000 nonrecourse debt x 10% profit sharing ratio] (5. December 31 is majority interest taxable year and is also the required year end for Broken Rock.5% 4.5% 4. LLC Red Spot. Garrett’s basis in his partnership interest is equal to the $400. LLC Burnt Fork.5% 4. LLC Wildfire.Forming and Operating Partnerships a. Streamside.5% 4. b. This means his capital gain from the sale of his partnership interest will be short-term capital gain.5% 4.5% 4. Because both George and Ray have a December 31 year end. [LO 3] Broken Rock LLC was recently formed with the following members: Name George Allen Elanax Corp. Inc. Ray Kirk Tax Year End December 31 June 30 December 31 Capital/Profits % 33.000 share of partnership debt or $500.3% What is the required taxable year-end for Broken Rock LLC? George Allen and Ray Kirk together own more than 50 percent of the profits and capital of Broken Rock.5% 4. Snowy Ridge. LLC Alpensee. [LO 3] Granite Slab LLC was recently formed with the following members: Name Nelson Black Brittany Jones Lone Pine. Inc. Inc.000. Inc.0% 4. 53. Because Garrett purchased his partnership interest. his holding period for the interest begins on the date the interest was purchased. Pale Rock.Chapter 20 . Thunder Ridge.5% 4.5% 20-44 .5% 4.0% 24.3% 33. LP Whitewater.5% 4. Inc. 52. Tax Year End December 31 December 31 June 30 October 31 September 30 July 31 March 31 June 30 October 31 October 31 June 30 October 31 January 31 September 30 Capital/Profits % 22.3% 33.5% 4. LP Straw Hat. As a result.000 amount he paid for it plus his $100. LLC Lakewood. he only has a three month holding period before the partnership interest is sold. Nelson Black and Brittany Jones are principal partners because they individually own more than 5 percent of the profits and capital of Granite Slab.Chapter 20 . Moreover. Therefore. there is no majority interest taxable year. 20-45 . they both have a December 31 year end. the required year end of the partnership is year end of the principal partners or December 31. However.Forming and Operating Partnerships What is the required taxable year-end for Granite Slab LLC? Because none of the partners with the same year end together own more than 50 percent of the capital and profits of Granite Slab. Tax Year End December 31 March 31 November 30 Capital/Profits % 35% 25% 40% What is the required taxable year-end for Rock Creek LLC? Rock Creek does not have a majority interest taxable year because no partner or group of partners with the same year end owns more than 50 percent of the profits and capital interests in Rock Creek.Forming and Operating Partnerships 54.25% erties. will provide its members the least aggregate deferral. December 31. Total Aggregate Deferral 40% 12/31 3/31 11/30 0 . LLC Chavez Builders. Tax Year End December 31 June 30 October 31 Capital/Profits % 40% 25% 35% What is the required taxable year-end for Tall Tree LLC? 55.15 0 3. Inc.35 Mark Banks 35% Highball Prop. March 31.35 20-46 . LLC Chavez Builders.Inc.75 4. The table below illustrates the required computations: Possible Year Ends 12/31 Year End 3/31 Year End 11/30 Year End Members % Tax Year Months Deferral* (MD) 0 3 11 % x MD Months % x MD Deferral* (MD) 9 0 8 Months Deferral* (MD) 1 4 0 %x MD . or November 30. because all three principal partners in Rock Creek have different year ends.4 5. Rock Creek must decide which of three potential year ends.35 1 0 1. Also. Inc.2 6. the principal partner test is not met. LLC Perry Homes. As a result. [LO 3] Tall Tree LLC was recently formed with the following members: Name Eddie Robinson Pitcher Lenders.Chapter 20 .15 3. [LO 3] Rock Creek LLC was recently formed with the following members: Name Mark Banks Highball Properties. 20-47 . As the table above indicates.Forming and Operating Partnerships *Months deferral equals number of members between proposed year end and partner’s year end. Rock Creek must use November 30 as its year end because it provides the least amount of aggregate deferral to the members.Chapter 20 . 2002-38. [LO 3]{Research} Ryan. partnerships defined as “tax shelters” are ineligible to use the cash method. Dahir. it may elect to have a September 30. other than a limited partner. [LO 3] {Research}Ashlee. Broken Feather can elect to have its year end fall up to three months ahead of its normal required calendar year end. partnerships without corporate partners may use the cash method of accounting. Although Tally Industries has historically been profitable. However. if more than 35 percent of losses in a given year are allocated to either limited partners or 20-48 .} b. October 31. Thus. and it can establish the same thing for the two preceding years ending on August 31. it must calculate and deposit a Section 7519 payment with the IRS to offset the deferral benefit the partners receive by having the year end fall before December 31. or November 30 year end under Section 444. which generates annual gross receipts of over $10 million. including LLC members. and Kate manage the business. Can they change to an August 31 year-end and. if so. According to Section 448(b)(3). Proc. The members would like to change their tax year-end and have asked you to address the following questions: a. who does not actively participate in the management of the enterprise. Each has a one-third interest. how do they make the change? {Hint: See Rev.} a. but Albee LLC is a nonmanaging member. and Bill have operated Broken Feather LLC for the last four years using a calendar year-end. partnerships that are tax shelters may not use the cash method of accounting. Kate. how do they make the change? {Hint: See § 444. their busy season has run from June through August. If Broken Feather can establish that 25 percent of its gross receipts for the current twelve month period ending on August 31 fell within the months of July and August. b. this provision likely also applies to LLCs because Section 464(e)(2) defines a limited entrepreneur as any person. Under Section 444. if so. 57. 2002-38. the members want to know whether Tally Industries can use the cash method of accounting. then Broken Feather can change its year end to August 31 under Rev. Since they began operating. Ashlee. for the last three years losses have been allocated to the members. Hiroki.Forming and Operating Partnerships 56. Section 1256(e)(3)(B) defines a syndicate as any partnership that allocates more than 35 percent of its losses to either limited partners or “limited entrepreneurs”. Section 461(i)(3)(B) includes “syndicates” among the other categories of “tax shelters”. Why or why not? {Hint: See § 448(b) (3)} Generally.Chapter 20 . Hiroki. with 35 percent of their gross receipts coming in July and August. Given these facts. However. Proc. In summary. and Albee LLC each own a 25 percent interest in Tally Industries LLC. In addition to limited partnerships. Can they change to a September 30 year-end and. if it makes the Section 444 election. Forming and Operating Partnerships to LLC members not actively participating in the management of an LLC. a significant number of limited partnerships and LLCs that would otherwise qualify are denied the use of the cash method. 20-49 .Chapter 20 . the limited partnership or LLC will be not be permitted to use the cash method. Because of these restrictions. Chapter 20 .000) Given these items. expenses. Tally will be able to use the cash method. 58.MACRS Amortization of organization costs Guaranteed payments Ordinary Business Income Separately Stated Items on Schedule K-1: Long-term capital gains Guaranteed payments Cash distributions Amount $40. and cash distributions must be separately disclosed so that partners can reduce the tax basis of their partnership interests by the amount of the distributions.000) $13.000 $2.000 $2.000) (3.000) ($1.000 $10. 20-50 .000 $2.000 Note that guaranteed payments must be separately disclosed to the partners that receive them. and distributions: Sales revenue Long-term capital gains Cost of goods sold Depreciation .MACRS Amortization of organization costs Guaranteed payments to partners for general management Cash distributions to partners $40. what is Turtle Creek’s ordinary business income (loss) for the year? Turtle Creek’s ordinary business income is calculated in the table below: Description Sales revenue Less: Cost of good sold Depreciation .000) (1.000) ($2.000 (13.000 ($13.000) ($10. [LO 4] Turtle Creek Partnership had the following revenues.000) (10. gains.Forming and Operating Partnerships Because only 25 percent of Tally Industries’ loss for the year is allocated to a member that does not actively participate in management and it does not have a corporate member. losses.000) ($3. Georgio’s allocation of ordinary business income is reflected in the table below: Description Total Amount 20% Allocated to Georgio Sales revenue Less: Cost of good sold Depreciation .000) (3. [LO 4] Georgio owns a 20 percent profits and capital interest in Rain Tree LLC.Forming and Operating Partnerships 59.000) ($10.000) $6.000 $11.000) $27.000) *Assume the §179 property placed in service limitation does not apply.400 20-51 .000) (11.000) ($11.000 $5.000 ($26.000 ($3.MACRS Employee wages Guaranteed payments Ordinary Business Income $70.000 (26. a.000) ($3.000) (3. and losses: Sales revenue Gain on sale of land (§1231) Cost of goods sold Depreciation .Chapter 20 . expenses.000) ($3. Rain Tree had the following revenues. How much ordinary business income (loss) is allocated to Georgio for the year? b.MACRS Section 179 deduction* Employee wages Fines and penalties Municipal bond interest Short-term capital gains Guaranteed payment to Sandra $70.000 $4. For the current year. What are Georgio’s separately stated items for the year? a. gains. Chapter 20 .Forming and Operating Partnerships b. Georgio’s separately stated items are calculated in the table below: 20-52 . 000) 800 1.000) 4. b. assuming G&P is a limited partnership and Gary is a limited partner.000 (10.000.000) ($3.Forming and Operating Partnerships Description Total Amount 20% Allocated to Georgio Separately Stated Items on Schedule K-1: Section 1231 gains Section 179 deduction Short-term capital gains Municipal bond interest* Fines and penalties* $11.000) a.200 (600) *Although these amounts are not included in Georgio’s taxable income computation.MACRS Employee wages Cash charitable contributions Municipal bond interest Other expenses $70. Compute Gary’s share of ordinary income (loss) and separately stated items to be reported on his year 1 Schedule K-1. What do you believe Gary’s share of self-employment income (loss) to be reported on his year 1 Schedule K-1 should be. Compute Gary’s share of self-employment income (loss) to be reported on his year 1 Schedule K-1.000 (3.000) ($9. assuming G&P is an LLC and Gary spends 2.200 (2.000 ($2. c.000 hours per year working there full time? 20-53 . including his self-employment income (loss).000 $8.000 6. and that Gary and Prudence will share the remaining profits or losses in a 45/55 ratio.000) ($14.000 ($38. the G&P partnership reports the following results: Sales revenue Gain on sale of land (§ 1231) Cost of goods sold Depreciation . [LO 4] The partnership agreement of the G&P general partnership states that Gary will receive a guaranteed payment of $13. they must be separately disclosed because they affect Georgio’s tax basis in his LLC interest.Chapter 20 . 60.000) $2.000) $2. For year 1. 000) Depreciation .300 ($2. and self-emDescription Total Amount Allocated to Gary Explanation Sales revenue $70.000 ordinary loss] $3.700) ordinary business loss allocated to Gary + $13.000 ($3.000) $13.000) Guaranteed payments (13.000 $7.000 Less: Cost of good sold (38.Chapter 20 . separately stated items.000) Employee wages (14.MACRS (9.000 $2.000 guaranteed payment ployment income are calculated in the table below: 20-54 .000) Other expenses (2.000 [$13.600 45% allocation to Gary ($1.000) ($2.350) 45% allocation to Gary $13.000 Gary’s guaranteed payment $900 45% allocation to Gary $10.000 guaranteed payment $6.Forming and Operating Partnerships Gary’s ordinary business income.000) Ordinary Business Loss ($6.700) 45% allocation to Gary Separately Stated Items on Schedule K-1: Section 1231 gains Cash charitable contributions Guaranteed payment Municipal bond interest Self-employment income $8. 000 $70.000) ($14.Forming and Operating Partnerships a.700 share of ordinary business loss will reduce his $13. recorded the following items for its current tax year: Rental real estate income Sales revenue Section 1245 recapture income Interest income Cost of goods sold Depreciation .300 of self-employment income (because he spent more than 500 hours working in the trade or business of the LLC).000 $2.MACRS Supplies expense Employee wages Investment interest expense Partner’s medical insurance premiums paid by Hoki Poki $2.} 20-55 .irs. {Hint: See Schedule K-1 and related preparer’s instructions at www.000 guaranteed payment he received. §1. identify the items that should be included in computing its ordinary business income (loss) and those that should be separately stated.000) ($1. a cash-method general partnership.000 $8. 61.000) ($3.000) As part of preparing Hoki Poki’s current year return. In this instance.1402(a)-2. the proposed regulations provide Gary with a favorable interpretation of the law.000) ($1. then his self-employment income would equal the $13. Under Proposed Reg. b.000) ($9.Chapter 20 .000 guaranteed payment leaving him with $10.000 ($38. Gary’s $2.gov. If Gary is a limited partner. [LO 4] {Research} Hoki Poki. Buy Rite LLC received $300.000 due to tax depreciation taken. Because the remaining $100.} Buy Rite’s self-employment income does not increase due to the sale of the equipment. At the time of the sale. the basis in the equipment had been reduced to $100. [LO 4] Jhumpa. and Kelly are all one-third partners in the capital and profits of Firewalker general partnership.Forming and Operating Partnerships 62. Buy Rite must insure that the $100.000 of ordinary Section 1245 recapture is subtracted from its ordinary business income or loss when calculating its self-employment income. gains from the sale of equipment are not included in Buy Rite’s self-employment income.Chapter 20 . Firewalker’s income statement for the current year reflects the following revenues and expenses: 20-56 .000 when it sold a machine it had purchased for $200. Stewart. How much did Buy Rite’s self-employment earnings increase when the equipment was sold? {Hint: See §1402(a)(3). Thus.000 three years ago to use in its business.000 of Section 1231 gain is separately stated. it is not included in ordinary business income or loss and therefore will not be included in self-employment income. In addition to their normal share of the partnership’s annual income.000 to compensate them for additional services they provide. 63. Jhumpa and Stewart receive an annual guaranteed payment of $10. According to §1402(a)(3)(C). [LO 4] {Research} On the last day of its current tax year. 000 3.000 a. How will it allocate these amounts to its partners? c.Forming and Operating Partnerships Sales revenue Interest income Long-term capital gains Cost of good sold Employee wages Depreciation expense Guaranteed payments Miscellaneous expenses Overall net income $340.000) (20.500) $97. How much self-employment tax will each partner pay assuming none have any other source of income or loss? 20-57 .000) (75.300 1.000) (28. how much ordinary business income (loss) and what separately stated items [including the partners’ self-employment earnings (loss)] will it report on its return for the year? b.200 (120.000) (4.Chapter 20 . Given Firewalker’s operating results. 500 ordinary business income (because ordinary business income from a general partnership is always treated as self-employment income by the partners) plus the $20.500 $30.000 in Description Sales revenue Less: Cost of good sold Employee wages Depreciation expense Misc.500 $40. Note that each partner’s self employment income consists of her/his individual shares of ordi- 20-58 .833 $1.500) (20.833 $30.100 $400 $40.300 $1.833 $30.833 guaranteed payments made to Dave and Stewart. The table above reflects the partner’s shares of ordinary business income and her/his separately stated items.000) (28. a.000) (4.000 (120. Note that the total self employment income for all partners consists of Firewalker’s $92.200 $400 $112.Forming and Operating Partnerships The table below illustrates Firewalker’s ordinary business income and separately stated items.000) $92.100 $1.000) (75. expenses Guaranteed payments Ordinary Business Income Separately Stated Items on Schedule K-1: Interest income Long-term capital gains Self-employment income Total Jhumpa $340.833 $1.Chapter 20 .833 Stewart Kelly $3.100 $400 $30. if any.Forming and Operating Partnerships nary business income plus the guaranteed payment she/he received.Chapter 20 . 20-59 . According to IRC §704 partnership allocations will be respected by the IRS unless they do not have “substantial economic effect.000 of taxable interest and $10. and each year the portfolio generates approximately $10. §1. The table below reflects the partner’s self-employment tax liability: Description Stewart (1)Self-employment in. §1. [LO 4] {Research} Lane and Cal each own 50 percent of the profits and capital of HighYield LLC.7041(b)(5) Example (5)(ii).3% $5.709 15.704-1(b)(5) Example (5) given that the special allocation to Lane and Cal simply changes the character of the income allocated to Lane and Cal but not the amount.704-1(b)(5) Example (5).} a.35% Explanation 64.357 (3) x (4) (1) x (2) 92. Is HighYield’s proposed special allocation acceptable under current tax rules? Why or why not? {Hint: See Reg.833 come (2) Percentage of self employment income subject to self-employment tax (3) Earnings from selfemployment (4) Self employment tax rate (7) Self-employment tax liability $37.474 15. Thus.Forming and Operating Partnerships b. HighYield owns a portfolio of taxable and municipal bonds. 20-60 . this allocation is not appropriate because it is not substantial.769 $37.769 $28. a.709 15. To take advantage of the difference in their marginal tax rates.} b. If the IRS ultimately disagrees with HighYield’s special allocation. Lane and Cal want to modify their operating agreement to specially allocate all of the taxable interest to Cal and all of the tax-exempt interest to Lane.$40.35% Kelly $30.3% $4. how will it likely reallocate the taxable and tax-exempt interest among the members? {Hint: See Reg.Chapter 20 .833 92.3% $5. Lane and Cal had been allocated 50 percent of each type of interest income.833 92.exempt interest.” The facts provided are almost identical to the general scenario described in Reg.704-1(b)(2)(iii)(b) and to the detailed facts described in §1.35% Jhumpa $40. Lane’s marginal tax rate is 35 percent while Cal’s marginal tax rate is 15 percent. Until now.704-1(b)(2)(iii)(b) and §1. §1.000 of tax. 000 10.704-1(b)(5) Example (5)(ii). then distributions. Eastside’s income statement for the current year reflects the following revenues and expenses: 20-61 . In addition to their normal share of the partnership’s annual income.Forming and Operating Partnerships b.000 to compensate them for additional services they provide. If his share of the partnership debt increased by $10. 65. [LO 5] Larry’s tax basis in his partnership interest at the beginning of the year was $10.000 as computed in the table below: Description Beginning Tax Basis Increase in Partner’s Share of Debt Partner’s Share of Income Ending Tax Basis Total Amount $10. [LO 5] Carmine was allocated the following items from the Piccolo LLC for last year: Ordinary business loss Nondeductible penalties Tax-exempt interest income Short-term capital gain Cash distributions Rank these items in terms of the order they should be applied to adjust Carmine’s tax basis in Piccolo for the year. the items above should be applied in the following order to adjust Carmine’s tax basis: Tax Exempt Income and Short Term Capital Gain (basis increasing items come first) Cash Distribution (distributions come after basis increasing items) Ordinary Business Loss and Non-Deductible Penalties (basis reducing items come last) 67. [LO 5] Oscar.Chapter 20 .000. Items that increase basis are applied first. Thus. §1.000. As described in Reg. Oscar and Felix receive annual guaranteed payments of $7.000 66. the IRS will likely assert that 50 percent of both the taxable and tax-exempt bond interest should be allocated to Lane and Cal. Felix. and Marv are all one-third partners in the capital and profits of Eastside general partnership. what is his tax basis in his partnership interest at the end of the year? $23.000 3. and then items that reduce basis.000 during the year and his share of partnership income for the year is $3.000 $23. Chapter 20 .Forming and Operating Partnerships 20-62 . 000 and all the debt was paid off on the last day of the year.000) (9. Finally.800 (210.500) $ 52.Chapter 20 .000 5.000) (28.000) (115.Forming and Operating Partnerships Sales revenue Dividend income Short-term capital gains Cost of good sold Employee wages Depreciation expense Guaranteed payments Miscellaneous expenses Overall net income $ 420. Felix and Marv had a tax basis of $80. a. All partnership debt is allocated equally among the partners.700 2. Oscar.000 In addition. What tax basis do the partners have in their partnership interests at the end of the year? b. How much gain will the partners recognize when the debt is paid off? What tax basis do the partners have in their partnership interests at the end of the year? 20-63 .000 by the end of the year. Assume the partners began the year with a tax basis of $10.000 in their interests at the beginning of the year.000) (14. Eastside owed creditors $120.000 at the beginning of the year but managed to pay down its debts to $90. Chapter 20 .333 (1)+(2)+(3)+(4)+(5 ) (7)Ending tax basis $87.($5.3% ($10.333 20-64 . All of the partners have an ending tax basis of $87.900 $933 $14.000) ($10.700 Dividend Income + $2.000 Felix $80.33% (5)Deemed distribution from debt repayment (6)Guaranteed payments received ($10.Forming and Operating Partnerships a.333 as calculated in the table below: Description (1)Beginning tax basis (including partners’ share of debt) (2)Dividend income (3)Short-term capital gains (4)Partner’s share of ordinary business income Oscar $80.900 $933 $5.333 $87.500 $1.500 $1.000] x 33.000 Explanation $1.900 $933 $14.33% $2.000) 0 $14.000 Marv $80.000) [$120.800 x 33.000 $90.800 Short-Term Capital Gains)] x 33.500[$52.000 overall net income .700 x 33.33% 0 Partners don’t increase the basis of their partnership interests by the amount of guaranteed payments received $87. and Mercedes are all one-third partners in the capital and profits of Oak Grove General Partnership.000) ($40.000 .500 $1.500 $1.700 x 33. Partnership debt is allocated among the partners in accordance with their capital and profits interests.($5.33% (5)Deemed distribution from debt repayment (6)Guaranteed payments received ($40. In addition to their normal share of the partnership’s annual income. Pam and Sergei receive annual guaranteed payments of $20.800 x 33.700 6.33% 0 Partners don’t increase the basis of their partnership interests by the amount of guaranteed payments received $12.000 to compensate them for additional services they provide. Oak Grove’s income statement for the current year reflects the following revenues and expenses: Sales revenue Dividend income Section 1231 losses Cost of good sold Employee wages 20-65 $476.800) (245.700 Dividend Income + $2. [LO 5] Pam.000) 0 $14.000) . Each partner recognizes gain of $12.900 $933 $14.000 Explanation $1.667 and has an ending basis of zero as calculated in the table below: Description (1)Beginning tax Basis (including partners’ share of debt) (2)Dividend income (3)Short-term capital gains (4)Partner’s share of ordinary business income Oscar $10.3% ($40.33% $2.Forming and Operating Partnerships b.667 0 $12.$0] x 33.900 $933 $5. Sergei.667 0 68.500 [$52.900 $933 $14.600 (3.667 [(5)+(1)+(2)+(3)+(4) ] 0 Generally (1)+(2)+(3)+(4)+(5) but may not go lower than zero (7)Gain recognized by partners (8)Ending tax basis $12.Chapter 20 .000 overall net income .000 Marv $10.000) [$120.000 Felix $10.800 Short-Term Capital Gains)] x 33.000) (92. Chapter 20 .000) (11.500) $ 60.000) (40.000 20-66 .Forming and Operating Partnerships Depreciation expense Guaranteed payments Miscellaneous expenses Overall net income (31. 600 x 33.000 Explanation Given (3)Partner’s share of ordinary business income $19.200 $6. Also.000? a.000 in their interests at the beginning of the year. Sergei’s basis is $65.000 Pam :[( $150. a.800) Section 1231 Losses)] x 33.000 20-67 .000 as computed in the table below: Description (1)Beginning tax basis (including partners’ share of debt) (2) Dividends income $2.000 at the end of the year. what tax basis do the partners have in their partnership interests at the end of the year assuming the liquidation value of the additional capital interest Pam receives at the end of the year remains at $40.33%)] Pam Sergei Mercedes $50.000. Pam’s basis is $140.000 at the beginning and $150.000 x 40%) – ($90.200 $2. Sergei and Mercedes had a tax basis of $50. the partnership donated $12. in addition to the expenses listed above. and Mercedes’s basis is $65.000.000.33%)] Other Partners: [($150.067 [$60.067 $19.3 percent to 40 percent at the end of the tax year in exchange for additional services she provided to the partnership.200 $2.3% $15.000 $50. If.000 $50.000 x 33.600 Dividend Income .000 x 33.33% (Pam’s profits interest doesn’t increase until the end of the year) $19.Forming and Operating Partnerships In addition.000 to a political campaign.($3. Oak Grove owed creditors $90.067 (4) Debt increase (deemed cash contribution) $30.000 $15. and Pam. What tax basis do the partners have in their partnership interests at the end of the year? b. Sergei and Mercedes agreed to increase Pam’s capital and profits interest from 33. The liquidation value of the additional capital interest Pam received at the end of the tax year is $40.000 x 30%) – ($90.000 overall net income ($6.Chapter 20 . 000 of partnership ordinary business loss.000 of recourse debt and $5.000 in part b.000 $65. Pam’s basis is $136.000)($12.67% capital interest to Pam is a guaranteed payment to Pam and a deduction allocated equally to other partners 0 0 Partners don’t increase the basis of their partnership interests by the amount of cash guaranteed payments received ($1. Sergei’s basis is $61.000 as computed in the table below: Description Ending tax basis given facts in part a.267) ($3.000 $65.33% $140. His share of partnership debt at the beginning and end of the year consists of $5.000) x 33.000. [LO 6] Alfonso began the year with a tax basis in his partnership interest of $30. he was allocated $40.000) ($4.000 $65.000 ($4.33% Non-deductible expenses must reduce a partner’s tax basis New ending basis given facts $136.000. During the year.000 of nonrecourse debt.800) x 33.000) ($20.000 ($20.000Sum of (1) through (7) (6) Cash guaranteed payments received (7) Section 1231 losses (8)Ending tax basis b.000 $61.267)($1.67% capital interest $40. 20-68 .000.000 of passive income from other sources. $61.Forming and Operating Partnerships (5) Pam’s new 6.267) ($1.000) Additional 6.000See solution to part a. above ($4.000) Sergei Mercedes Explanation $65.Chapter 20 . and Mercedes’ basis is $61. Alfonso does not materially participate in this partnership and he has $1. Campaign contribution Pam $140.000 69. Chapter 20 .Forming and Operating Partnerships 20-69 . what are the carryover amounts and what is their character? {Hint: See Reg.000 of the $25.Chapter 20 . Rul.000 loss remaining after the tax basis and at-risk limitations to the extent he has passive income from other sources. Because Alfonso’s basis before the loss allocation is $30.000 loss allocation is limited by his tax basis and will carryover to the following year.000 of loss remains after the tax basis and at-risk limitations and Alfonso has a $5.} b. How much of Alfonso’s loss is limited by his at-risk amount? c.000 loss not already limited by Alfonso’s tax basis.} 20-70 .000 of his $40.000 of partnership ordinary business income.704-1(d). he was allocated $20.000 at-risk carryover. he may deduct $1. §1. [LO 5.000 passive activity loss carryover.000.000 loss currently and will have a $24.000 regular tax basis less the $5. Of the $30. he may only deduct the $25. 6] {Research} Juan Diego began the year with a tax basis in his partnership interest of $50. $70. $25. Thus.000.000.000 of short-term capital losses.000 nonrecourse debt not allowed in calculating the at-risk amount). How much of Alfonso’s loss is limited by the passive activity loss rules? a. b.000 ($30. 66-94. $30. How much of Alfonso’s loss is limited by his tax basis? b. a. c. Because Alfonso doesn’t materially participate in the partnership. What items related to these allocations does Juan Diego actually report on his tax return for the year? {Hint: See Reg.Forming and Operating Partnerships a.000 is limited because Alfonso’s at-risk amount is only $25. $5. and received a cash distribution of $50. 70.704-1(d)(2) and Rev. §1. During the year. Thus.000 of §1231 losses. If any deductions or losses are limited. $10. 66-94. his remaining basis of $20.000 and.000) $30.000/$100. According to Rev. [LO 6] Farell is a member of Sierra Vista LLC. as a partner in the Riverwoods Partnership. Assuming Farrell’s Riverwoods K-1 indicates passive income of $30.000 loss carryover (due to his $20.000 share of ordinary business income and then reduce it by his $50. and passive activity loss limitations.000 Section 1231 losses Short-term capital losses b. Juan Diego’s $80. Because of the time he spends in other endeavors. On January 1. As indicated in the table above.000. and passive activity loss limitations.000 cash distribution.000 ($20. at-risk.000. Rul.000 $24. at-risk. §1.704-1(d)(2) describes how Juan Diego’s $20.000 $6. Determine how much of the Sierra Vista loss Farell will currently be able to deduct on his tax return for year 1. it is not currently involved in real estate either as an investor or as a developer. Juan Diego should increase his basis first by his $20.000 tax basis in his LLC interest that includes his $90.000 Section 1231 loss and a $24. and passive activity loss limitations.000/$100. Farell has a $100.000 ($20.000 will be reduced to zero by the $70. at-risk. a. By the end of the year.000. determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1 and list the losses suspended due to tax basis. determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1 and list the losses suspended due to tax basis.000 x $30. At this point. Although Sierra Vista is involved in a number of different business ventures. Assuming Farrell is deemed to be an active participant in Sierra Vista. c. His share of the Sierra Vista losses for year 1 is $120.000 tax basis limitation) will be characterized as a $56. b.000) (1) – (2) Loss Carryover $56. he has year 1 Schedule K-1 passive income of $5. Farell does not materially participate in Sierra Vista. Reg. 71.000 tax basis before considering the loss allocations should be allocated to the two types of losses.000 Section 1231 losses and $30.000 short-term capital loss. year 1.000 short-term capital losses allocated to him. and list the losses suspended due to tax basis.000 share of Sierra Vista’s general debt obligations.Forming and Operating Partnerships a. 20-71 .000 x $70.Chapter 20 . Sierra Vista’s general debt obligations have increased to $100.000 $14. The table below illustrates the required calculations: (1) Original (2) Amount Deducted Loss Currently $70. [LO 6] {Research} Jenkins has a one-third capital and profits interest in the Maverick General Partnership. Maverick incurred a $30. year 1.000 in nonrecourse debt that is not secured by real estate. 72. Because Maverick is a rental real estate partnership. 20-72 . His share of the Maverick losses for year 1 is $105.Forming and Operating Partnerships a. During the year. Jenkins is deemed to be a passive participant in Maverick. Jenkins is not involved in any other passive activities and this is the first year he has been allocated losses from Maverick. On January 1.000 tax basis in his partnership interest. Maverick has $120.000 of general debt obligations and Jenkins has a $50.Chapter 20 .000. 000 loss suspended by the passive activity loss limitation as illustrated in the table below: 20-73 .000 loss suspended by the at-risk limitation. Reg. and a $50. a $30.Chapter 20 .000 loss suspended by the tax basis limitation. and passive activity loss limitations.Forming and Operating Partnerships a.} a. and list the losses suspended due to tax basis. year 2.465-66(a). at-risk. and he will have a $25. Jenkins may not deduct any losses currently. If Jenkins sells his interest on January 1. what happens to his suspended losses from year 1? {Hint: See Sennett v. b. §1. Determine how much of the Maverick loss Jenkins will currently be able to deduct on his tax return for year 1. Commissioner 80 TC 825 (1983) and Prop. Forming and Operating Partnerships 20-74 .Chapter 20 . 000) business loss (5) Loss clearing ($80.000 General debt obligaTax basis and Attions of general partrisk amount nerships are treated as recourse debt. Thus.000) Loss limited to the Tax basis $80.000) (7) .000) (10) – (12) tivity loss carryover Description 20-75 .000 (1) + (2) At-risk amount before ordinary business loss (4) Ordinary ($105.000 tax basis hurdle (6)Loss suspend.000 at-risk amount (9) Loss sus($30.Passive ActiviExplanation Limitation tion ty Limitation (1) Beginning $50.000) (4) .000) (8)Jenkins is not a tivity loss material participant (11) Passive in$0 Given come (12) Loss used to $0 Loss only used to the offset Passive inextent of passive income come (13) Passive ac($50.000 $50. (2) Increase in $30.(8) pended by Atrisk hurdle (10) Passive ac($50.000 $0 Nonrecourse debt nonrecourse generally not includdebt ed in at-risk amount.($25.(5) ed by Tax basis hurdle (7) Loss clearing ($80. Jenkins’ beginning at-risk amount is the same as his beginning tax basis.000 $50.Chapter 20 .Forming and Operating Partnerships Tax Basis At-risk Limita.000) (5) Tax basis hurdle (8) Loss clearing ($50. (3) Tax basis and $80.000) Loss limited to At-risk hurdle $50. Chapter 20 .Forming and Operating Partnerships 20-76 . b. At the beginning of the current year Suki and Steve had a tax basis of $170. 73.46566(a) provides that Jenkins may utilize the $30. and passive activity loss limitations.000. even though Lorinda’s ordinary business loss for the year was $400.Forming and Operating Partnerships b. a.000 of Lorinda’s debt. his advisor recommends refusing the cash distribution and personally guaranteeing $100. Lorinda owes its general creditors $300. In addition. [LO 6] {Planning} Suki and Steve own 50 percent capital and profits interests in Lorinda LLC. Commissioner 80 TC 825 (1983). Jenkins will lose the $25. Reg. Finally. Because of the time commitment to operate a baseball team. Assume that sometime before receiving the $10. If Steve follows his advisor’s recommendations. Jenkins may deduct the $50. without the right to be reimbursed by Suki. Determine how much of the Lorinda loss Suki and Steve will each be able to deduct on their current tax returns.000 loss suspended by the at-risk limitation to offset any gain he would otherwise report from the disposition of his partnership interest.Chapter 20 . a partner with losses suspended by the tax basis limitation disappear when the partnership interest is sold. both Suki and Steve spent more than 1. how much additional Lorinda loss can he deduct on his current tax return? How does Steve’s decision affect the amount of loss Suki can deduct on her current return and the amount and type of her suspended losses? 20-77 . and list their losses suspended by the tax basis.000 passive activity loss carryover in the year of disposition.500 hours during the year operating Lorinda.000 loss suspended by the tax basis limitation. Shortly before the end of the year they each received a $10.000 cash distribution. §1.000 (at the beginning and end of the year) that is not secured by firm property or guaranteed by any of the members. Although the debt incurred to build the stadium was paid off several years ago. To help Steve utilize more of the losses allocated from Lorinda in the current year. Thus. at-risk. Lorinda operates the local minor league baseball team and owns the stadium where the team plays.000 cash distribution. Steve is advised by his tax advisor that his marginal tax rate will be abnormally high during the current year because of an unexpected windfall.000 in their LLC interests including their share of debt owed to the general creditors. According to Sennett v. Prop. 000) (3) Tax basis and $160.000 loss suspended by the tax basis limitation. ($150.000) (5) Loss limited to $10. The members (either Steve or Suki) may deduct $10.000 x50% Loss limited to $160.000 less than their beginning tax basis.(8) as illustrated in the table below: 20-78 . This amount is currently deductible because Steve is an active participant in the activity.000 General debt obligations of LLCs Tax basis and Atare treated as nonrecourse debt.Chapter 20 .000) ($10.000) (7) . risk amount Thus.Forming and Operating Partnerships a.(5) ($160. (2) Distribution ($10.000 $10.000) ed by Tax basis hurdle (7) Loss clearing Tax basis hurdle (8) Loss clearing At-risk hurdle and currently deductible (9) Loss suspended by Atrisk hurdle $400. and they will have a $40.000 at-risk amount on line (3).000 in losses currently.000 loss suspended by the at-risk limitation Tax Basis At-risk LimitaExplanation Limitation tion (1) Beginning $170.000) business loss (5) Loss clearing ($160.000 $20. Suki or Steve’s beginning at-risk amount is $150.000 (1) + (2) At-risk amount before ordinary business loss Description (4) Ordinary ($200.000 tax basis (4) .000) the Tax basis hurdle (6)Loss suspend.000) ($10. and a $150.($40. $150.000 + 50% x debt allocation $200.000 – 0] for at-risk amount because guaranteeing the debt makes it recourse debt (3) Tax basis and $220.000 [(100. Thus.000 in losses currently (a $110. (9) Loss sus($80.000) business loss (5) Loss clearing ($200. Steve’s beginning at-risk amount is $150.000) .000 $100.000) (7) .000 $120.(5) ed by Tax basis hurdle (7) Loss clearing ($200.000 increase over the loss he could deduct in part a.000 (1) + (2) At-risk amount before ordinary business loss (4) Ordinary ($200.000 less than his beginning tax basis.000) Loss is less than tax basis the Tax basis limitation hurdle (6)Loss suspend$0 (4) . Steve may deduct $120. and will Tax Basis At-risk LimitaExplanation Limitation tion (1) Beginning $170. This and currently deamount is currently deductible ductible because Steve is an active participant in the activity.000) Loss is limited to at-risk At-risk hurdle amount on line (3).000) (5) Tax basis hurdle (8) Loss clearing ($120.000 loss suspended by the at-risk limitation as illustrated in the table below: 20-79 .000 General debt obligations Tax basis and Atof LLCs are treated as risk amount nonrecourse debt.000 $20.).(8) pended by Atrisk hurdle Description have a $80.Forming and Operating Partnerships Under these facts.Chapter 20 .000] for tax basis and [100. (2) Increase in $50. Chapter 20 .000 loss suspended by the at-risk limitation as illustrated in the table below: 20-80 . and she will have a $90.000 in losses currently (the same amount of loss as in part a.Forming and Operating Partnerships Suki may deduct $10.).000 loss suspended by the tax basis limitation and a $100. Forming and Operating Partnerships 20-81 .Chapter 20 . At the beginning of the current year.000) ($10. This amount is currently deductible because Suki is an active participant in the activity.000 $10.000) $0 [($200.000 (1) + (2)+ (3) At-risk amount before ordinary business loss (5) Ordinary ($200.000) business loss (6) Loss clearing ($110.000 and neither member is involved in other activities that generate passive income.000 x 50%)] (4) Tax basis and $110. Alpine’s debt (both at the beginning and end of the year) consists of $1.(8) Description ($100. [LO 6]{Research} Ray and Chuck own 50 percent capital and profits interests in Alpine Properties LLC.000 General debt obligations Tax basis and Atof LLCs are treated as risk amount nonrecourse debt.000 less than her beginning tax basis. (2) Distribution ($10.($90. (7) .000 in his LLC interest including his share of the nonrecourse mortgage debt.000) ed by Tax basis hurdle (7) Loss clearing Tax basis hurdle (8) Loss clearing At-risk hurdle and currently deductible (9) Loss suspended by Atrisk hurdle (5) .000 $20.000) (3) Decrease in ($50.Forming and Operating Partnerships Tax Basis At-risk LimitaExplanation Limitation tion (1) Beginning $170.(6) ($110.000) 74. Suki’s beginning at-risk amount is $150.000) ($10. Thus. Ray and Chuck each had a tax basis of $250. and Ray and Chuck each work full time (over 1000 hours per year) managing Alpine.000) (6) Loss is limited to at-risk amount on line (4).500.000 x 50% ) – debt allocation ($300. Alpine builds and manages rental real estate.000) Loss is limited to the tax the Tax basis basis hurdle (6)Loss suspend.Chapter 20 . 20-82 . Alpine’s ordinary business losses for the current year totaled $600.000 in nonrecourse mortgages obtained from an unrelated bank and secured by various rental properties. (3) (3) Loss limited to $250.000 at-risk amount (7) .(8) (2) Ordinary ($300.Forming and Operating Partnerships a. it is included in both the tax basis and at-risk amount 50% x $600. How much of each member’s loss is suspended because of the passive activity loss limitation? {Hint: See §469(b)(7).000) Tax basis hurdle (6) Loss clearing ($250.Passive ActiviLimitation tion ty Limitation $250.000 $250. How much of each member’s loss is suspended because of the tax basis limitation? b.000) pended by Tax basis hurdle (5) Loss clearing ($250.000 tax basis (2) . How much of each member’s loss is suspended because of the at-risk limitation? c.} a.000) At-risk hurdle (7) Loss suspended by Atrisk hurdle $0 20-83 .000) business loss (3) Loss clearing ($250.Chapter 20 .000 of loss suspended because of the tax basis limitation as reflected in the table below: Description (1) Beginning Tax basis and Atrisk amount Tax Basis At-risk Limita.000) the Tax basis hurdle (4) Loss sus($50.000 Loss limited to $250. Each member will have $50.000 Explanation Because the LLC’s mortgage debt is qualified nonrecourse financing. 000. §469(b)(7) provides an exception for taxpayers that work more than half of the time in real property trades or businesses and work more than 750 hours in real property trades or businesses in a given year. none of the members’ loss allocation will be suspended because of the at-risk limitation. both members will be treated as active participants and will therefore be able to immediately deduct $250. As indicated in the table above. 20-84 .Chapter 20 . Given the facts in this problem. Although rental real estate ventures are generally treated as passive activities under §469(c)(2).000 loss remaining after the tax basis and atrisk limitations (see table in part a. c.Forming and Operating Partnerships b. Each member’s $250.) is deductible currently. d.Forming and Operating Partnerships Comprehensive Problems 75.. For the first year of operations. All three partners agreed to split profits and losses equally. 4. Deanne. and deductions that the partners must show on their individual income tax returns that include the results of the partnership’s first year of operations. the partnership records disclosed the following information: Sales revenue $470. [LO 2.000.000 Long-term capital gains $2. The land was also encumbered with a $70. b.Chapter 20 . (Optional) Using the information generated in answering parts a.000 principal payment on the mortgage.000 a.000 Operating expenses $70. Aaron and Deanne each contributed $110.000 and Keon transferred an acre of undeveloped land to the partnership. List the separate items of partnership income. and Keon formed the Blue Bell General Partnership at the beginning of the current year. The land had a tax basis of $70. gains. prepare Blue Bells’ page 1 and Schedule K to be included with its Form 1065 for its first year of operations along with Schedule K-1 for Deanne. What are the partners’ adjusted bases in their partnership interests at the end of the first year of operations? 20-85 .000 Cost of goods sold $410. c. 5] Aaron.000 nonrecourse mortgage for which no one was personally liable. losses. Compute the adjusted basis of each partner’s interest in the partnership immediately after the formation of the partnership. and b. At the end of the first year Blue Bell made a $7.000 and was appraised at $180.400 Section 1231 gains $900 Charitable contributions $300 Municipal bond interest $300 Salary paid as a guaranteed payment to Deanne (not included in expenses) $3. 000) $0 $110.[(1)+ (2)+ (3)] if positive. for Aaron is $133. This initial adjusted basis for Keon is $23.333 ($70.333 b.333 $110. otherwise 0 $133.000 Aaron Deanne Explanation $23.000 $23.Forming and Operating Partnerships a.000 $23. The partners’ shares of ordinary business loss and separately stated items are reflected in the table below: 20-86 . and for Deanne is $133.333 $133.Chapter 20 .333.333 $0 $0(4 ).333 as shown in the calculations with table below: Description (1) Basis in contributed land (2) Cash contributed (3) Debt allocated to partners (4) Relief from nonrecourse mortgage (5) Gain recognized Keon $70.333(1) + (2) + (3)+ (4) + (5) (6) Partners’ initial tax basis $23.333. 000) (3.000) (70.333) ($4.000) ($2.33% $300$900 x 33.Forming and Operating Partnerships Description (1) Partners’ initial Tax basis (2) Sales revenue Less: (3) Cost of goods sold (4) Operating expenses (5) Guaranteed payments (6) Ordinary Business Loss Separately Stated Items on Schedule K-1: (7) Long-term capital gains (8) Section 1231 gains (9) Municipal bond interest (10) Charitable contributions (11) Mortgage reduction (deemed cash distribution) Total Keon Aaron Deanne Explanation $23.33% $100$300 x 33.333) 20-87 .33% ($7.400 $900 $300 ($300) $800 $300 $100 ($100) $800 $300 $100 ($100) ($2.33% ($100)($300) x 33.333) $800$2.333)($7.33% ($2.000 (410.Chapter 20 .333 $133. above $470.000) x 33.000) ($4.000) ($13.33% $2.333)[Sum of (2) through (5)] x 33.400 x 33.333) ($4.333 $133.333See problem a. 334) ($1.767 20-88 .Forming and Operating Partnerships (12) Self-employment Loss ($10.000 guaranteed payment to Deanne 127.767(1) + (6)+ (7) through (11) Partners’ ending tax basis $17.000) ($4.333) ($4.333)Line 6 + $3.767 127.Chapter 20 . Chapter 20 .Forming and Operating Partnerships c. Blue Bell Partnership’s page 1 and Schedule K to be included with Form 1065 and Deanne’s Schedule K-1 are shown below: 20-89 . Forming and Operating Partnerships 20-90 .Chapter 20 . Forming and Operating Partnerships 20-91 .Chapter 20 . Lance is the limited partner.767. Aaron has an ending basis of $127. During the current year. To what extent does the tax basis limitation apply in restricting the partners’ deductible losses for the year? c. 5. 76. a.000 $2. [LO 4.000 $2.000 and Francesca has an ending basis of $0 as illustrated in the table below: Description (1) Partners’ initial Tax basis Basis Increasing Items: (2) Section 1231 gain Total Lance Francesca Explanation (Limited) (General) $10.000 $3.000 $500. the partnership reported the following results from operations: Net sales Cost of goods sold Operating expenses Short-term capital loss Tax-exempt interest Section 1231 gain $650. To what extent does the passive activity loss limitation apply in restricting their deductible losses for the year? Lance has an ending basis of $5.000 x 50% 20-92 . Francesca works full-time managing the partnership. the partnership distributed $3000 each to Lance and Francesca. Francesca is the general partner.Forming and Operating Partnerships d.000Given $6. and they share capital and profits equally. What outside basis do Lance and Francesca have in their partnership interests at the end of the year? b.000 $6. Keon has an ending basis of $17. These amounts are calculated in the table included with the solution to part b. Both the partnership and the partners report on a calendar-year basis. and the partnership did not carry any debt. At the start of the current year.000 $3.000 $160.000 On the last day of the year.000 $3. Lance and Francesca had bases of $10.000 and $3.767.000$6.767 and Deanne has an ending basis of $127.Chapter 20 . above.000 respectively. 6] The TimpRiders Limited Partnership has operated a motorcycle dealership for a number of years. 000) ($5. Thus.000 ($3.000) x 50% $0(6) + (10) + (11) or limited to a basis of zero.000) ($1.000 short-term capital loss is not limited because it is a portfolio rather than a passive loss.000(4) + (5) $650. a. Francesca’s total losses are limited to $4.000Sum of lines (1) through (3) ($3.Forming and Operating Partnerships (3) Tax-exempt interest (4) Basis Before Distributions (5) Cash distributions (6) Basis Before Loss Allocations (7) Sales revenue Less: (8) Cost of good sold (9) Operating expenses (10) Ordinary business loss (11) Short-term capital loss Partners’ ending tax basis $2.000) ($10. the tax basis limitation applies to Francesca.000—his tax basis prior to his loss allocations.000 $1.000) (160.000) $11. As indicated in the table in part a. b.000)($2.000 (500.000)Given $4.000 x 50% $7. Thus. The passive activity loss rules don’t apply to Francesca because he works full time managing the partnership and would be classified as a material participant.. His $1. Although Lance’s loss allocations are not limited because of his tax basis. his share of the ordinary business loss is classified as a passive activity loss because he is a limited partner.000) ($2.000 ($5.000 ordinary business loss as a passive activity loss until he either receives passive income or he sells his partnership income. he must carryover his $5.Chapter 20 .000$2. Lance’s loss allocations are not limited by his tax basis. 20-93 . however.000 $14.000 $1.000)[Sum of (7) through (9)] x 50% ($1.000) $5. 200 $300 $10. Use the proposed self-employment tax regulations to determine each member’s self-employment income or loss. What is Bar T’s tax basis and holding period in its land? d.000 $3. but LeBron and Dennis will devote less than two days per year to the operation. What are the members’ adjusted bases in their LLC interests at the end of the first year of operations? h. LeBron and Dennis each contributed $200. Compute the adjusted basis of each member’s interest immediately after the formation of the LLC. the partnership records disclosed the following information: Sales revenue Cost of goods sold Operating expenses Dividends Municipal bond interest Salary paid as a guaranteed payment to Susan (not included in expenses) Cash distributions split equally among the members at year-end $620.000 principal payment on the mortgage. The land was also encumbered with a $100.Chapter 20 . What are the members’ at-risk amounts in their LLC interests at the end of the first year of operations? 20-94 . None of the members have passive income from other sources. b.000 and Susan transferred several acres of agricultural land she had purchased two years earlier to the LLC. [LO 2.000 of accounts payable jointly guaranteed by LeBron and Dennis and had made a $9. gains.e. The land had a tax basis of $50. 4. and Susan formed the Bar T LLC at the beginning of the current year. Dennis.000 $1. At the end of the first year. For the first year of operations. Susan will work full-time operating the business.. Bar T had accumulated $40.000 and was appraised at $300.000 nonrecourse mortgage (i. deductions and other items that will be included in each member’s Schedule K-1 for the first year of operations.Forming and Operating Partnerships 77. qualified nonrecourse financing) for which no one was personally liable. When does each member’s holding period for his or her LLC interests begin? c. All three members agree to split profits and losses equally. g. The members plan to use the land and cash to begin a cattle-feeding operation. What is Bar T’s required tax year-end? e. 5] LeBron. What overall methods of accounting are available to Bar T? f.000 $670. losses. List the separate items of partnership income.000 $380.000 a.000. 667. The holding period for LeBron and Dennis begins when they receive their LLC interests because they only contribute cash.667. LeBron’s adjusted basis is $216.667(1) + (2) + (3) + (4) +(5) (7) Partners’ initial tax basis $216.33% ($100.667 $216.667 b.000 $200.[(1)+ (2)+ (3)+ (4)] if positive.667 $16. In contrast. otherwise 0 $16.000 $50.Forming and Operating Partnerships i.667 $0 $0 $0(5 ). Susan’s holding period includes the holding period for the land he 20-95 .000) (4) Debt allocated to partners (5) Relief from nonrecourse mortgage (6) Gain recognized $16.Chapter 20 .667[$100. and Susan’s adjusted basis is $16. How much loss from Bar T. will the members be able to deduct on their individual returns from the first year of operations? a.667 as calculated in the table below: Description (1) Basis in contributed land (2) Cash contributed (3) Debt allocated to susan only LeBron Dennis Susan Explanation $50.000] x 33. Dennis’ adjusted basis is $216. if any.000Nonrecourse debt > Susan’s tax basis in contributed property $16.000 $50.000 $200. Forming and Operating Partnerships contributed since Susan held the land as either a capital or Section 1231 asset. 20-96 .Chapter 20 . the hybrid method). Bar T receives a $50.000) Total LeBron Dennis $216.667 $216. However. It may generally use the cash method because it does not have a corporate member. Bar T must adopt a calendar year end because all of its members have calendar year ends. 20-97 .Forming and Operating Partnerships c. The member’s separately stated items are listed on lines (2). Note that LeBron and Dennis have self-employment income under the proposed regulations because they are responsible for some Description (1) Members’ Initial Tax Basis (2) Dividends (3) Municipal bond interest (4) Deemed cash contribution from accounts payable (5) Cash distributions ($3.000 $400 $100 $20.e.000 tax basis in the land and will include Susan’s holding period as part of its holding period.667See part a.000 of Bar T’s debt. above $400$1.667 $400 $100 $20. it must use the accrual method in accounting for its inventory related transactions (i.33% Accounts payable are only allocated to LeBron and Dennis because they guaranteed them ($1. (11).000) ($1.33% $100$300 x 33. Susan clearly has self-employment income under the proposed regulations because he works full time in the enterprise. e.200 x 33..000) ($1.000) $1. and (13) in the table below.200 $300 $40. (3). Bar T may adopt either the cash or accrual method of accounting. d.000 Susan Explanation $16.Chapter 20 . Susan must carry over $7.167 ($9. the repayment goes to reduce her share of the debt. As indicated in the table in part f.000 (380.500.667 ($136.500. and the ending basis for Susan is $0.667) or ($139.667 ($146. 20-98 .167 + ($146.667[Sum of (8) through (11)] x ) ) ) 33. the ending basis for LeBron is $89. $7.167 $236.000) (10.667Line (12) + ) ) )$10. above.000 guaranteed payment to Susan $0(7)+ (12) but not less than zero.33% ($430.000) $236.167Sum of (1) through (6) ($440.000) ($146.Chapter 20 .000) ($146.000 of the nonrecourse mortgage.000) (670.500) of ordinary loss.500 $89.667 ($146.500 f. the ending basis for Dennis is $89. Members’ ending Tax basis $89.000)Because Susan was originally allocated the first $50.Forming and Operating Partnerships (6) Deemed cash distribution to Susan for mortgage repayment (7) Member’s Tax Basis Before Loss Allocation (8) Sales revenue Less: (9) Cost of good sold (10) Operating expenses (11) Guaranteed payments (12) Ordinary Business Loss (13) Self-employment loss $620.667 ($146. they cannot deduct their losses currently and each has a $146. the members’ at-risk amounts will be less than the amount of their tax bases to the extent they are allocated nonrecourse debt that is not qualified nonrecourse financing. Generally.Forming and Operating Partnerships g. However. because the nonrecourse mortgage is qualified nonrecourse financing and the accounts payable are treated as recourse debt (i. above.Chapter 20 . h. her $146. given the facts provided. As for Susan.667 passive activity loss carryforward because they are not material participants in the enterprise.667 loss is initially limited to her $7. As indicated in the table in part f. However. they are guaranteed by LeBron and Dennis).500 loss carryforward. the members’ at-risk amounts are the same as their tax bases in part g. 20-99 . In this case.e. she may deduct the $7.667 loss allocated to LeBron and Dennis is not limited by their tax bases.. because she is a material participant in Bar T. the $146.167 currently.167 tax basis leaving her with a $139.
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