Sample Answers to Question 3
Partnership Tax
Spring 2006

Exam No. 1346: See pdf file here.

Exam No. 1415: See pdf file here.

Exam No. 1876

The entity is classified for tax purposes as a partnership, unless it elects to be taxed as an “association” (corporation).

Formation:

Upon formation, R’s contribution of $100K cash is treated as a non-taxable event under §721. The receipt of the contributions is also non-taxable as to the LLC. Under section 722, R’s outside basis in her partnership interest is equal to the basis of the property contributed: $100K. The partnership has an inside basis equal to the basis of the money contributed. 723. The pship has an inside basis of $100,000.

Assuming this pship would not be treated as an investment company if it was incorporated, neither S nor T will recognize gain or loss upon the contribution of the property each contributes. 721.

S’s basis in her pship interest will be the value of any cash contributed and the basis of any property contributed. 722. S contributed $50K cash and Greenacre (V: 50; b: 70), so her basis is $120K. This property has a built-in loss of $20K that will be allocated to S upon its sale/exchange. Because S is a dealer of real estate, this loss on this land would be ordinary. Section 724 preserves the character of the gain or loss that the property would have had in the hands of the contributing partner. Since the pship interest is received from ordinary income property, S’s holding period in her pship interest starts from the time she contributes the cash and land. S’s holding period in the land caries over to the pship under 1223(2). After S’s contribution, the pship has a basis of 220K (150 cash and 70 greenacre).

T’s basis in his pship interest will be the value of any cash contributed and the basis of any property contributed. 722. T contributed stock (V: 100; b: 115), so her basis is $115K. This stock has a built-in loss of $15K that will be allocated to T upon its sale/exchange. The stock is a capital asset and this future loss will be capital because section 724 preserves the character of the gain or loss that the property would have had in the hands of the contributing partner. Since the pship interest is received from a capital asset, T’s holding period from the stock (many years) tacks onto the holding period he has on his pship interest. T’s holding period in the stock carries over to the pship under 1223(2). After T’s contribution, the pship has a basis of 335K (150 cash and 70 greenacre and 115 stock). The balance sheet is as follows:

BALANCE SHEET
Assets	Basis	Value	Liabilities	Basis	Value
			Debt
Cash	150,000	150,000
Land	70,000	50,000	Capital
Securities	115,000	100,000	R	100,000	100,000
			S	120,000	100,000
			T	115,000	100,000
TOTAL:	335,000	300,000	TOTAL:	335,000	300,000

Sale of the stock:

When the pship sells the stock, there is a tax loss of 115,000 – 85,000 = $30,000 and there is a book loss of $100,000 - $85,000 = $15,000. Under the traditional method, all of the built-in gain or loss (here, $15,000 loss) must be attributed to the contributing party. So, T would be allocated the $15,000 precontribution loss (and his basis would go down) and the book loss would be allocated $5000 to each. The Pship basis would also go down by

NOTE: A partnership may disregard or defer application of section 704(c) in a single year if there is a small disparity b/w the book value and the adjusted basis of the contributed property. A small disparity means the total FMV of all property contributed by a partner during the taxable year doesn’t differ from the total adjusted basis of the property by more than 15% of the adjusted basis, and he total gross disparity doesn’t exceed $20K. Here, the small disparity exception would apply.

Because the stock was sold within 5 years of contribution, the loss passed through would be long term capital losses to the extent that the FMV exceeded the basis at the time of contribution: $15,000. The loss may be limited by 469, the passive loss rules.

Sale of greenacre:

The sale of greenacre presents ceiling rule issues. It is sold at a $65K book gain (115-50) and a 45K tax gain (115-70), but the loss was contributed with a $20K built-in loss. This loss should be allocated to T, but under the traditional method, T can recognize no loss in excess of the partnership’s loss, and the partnership didn’t have a loss. This will cause a disparity in the inside and outside bases.

The pship could elect the traditional method with curative allocations which would allocate the gains per the traditional rule now, but would reallocate later items of loss to her so that she gets her built-in loss. Under this method, the pship would assign an item of gain to the other partners. Eventually, the inside/outside basis mismatch would be fixed. It is important to note that the curative allocation needs to be an actual loss coming into the pship and of the same character as the loss S suffered (ordinary – see formation).

The pship could also elect to use the remedial method. Under this method, the pship would creates items of loss and gain to offset the effect of the ceiling rule at the time of sale. First it would allocate the full loss of $20K to T. Then it would create an item of ordinary income that it would distribute to R & T according to the partnership agreement. The inside/outside bases would match.