Partnership Tax
Bogdanski
Spring 1999

Sample Answer to Question 3

Part A

1999:  Allocations of the loss for tax purposes are made pursuant to the partnership agreement, IRC § 704(a).  The $300,000 loss is allocated $60,000 to Rick, $120,000 to Sally, and $120,000 to Tina.  The deductions are not (yet) "nonrecourse deductions," but the "qualified income offset" allows the loss to be allocated per the agreement, so long as this does not result in the creation of a negative capital account.

2000:  Rick has a capital account problem in this year.  He has not promised to restore a negative capital account, and so partnership losses pass through to him only to the extent of his remaining capital account, so long as the other partners also have positive capital accounts.  The loss passes through $40,000 to Rick, $130,000 to Sally, and $130,000 to Tim.

2001: At this point, the loss is a "nonrecourse deduction."  Under the regulations under IRC § 704(b), nonrecourse deductions can be allocated liberally, but only if a "minimum gain chargeback" provision is present in the partnership agreement.  Here there are no facts indicating that such a provision is present, which could result in the agreement not controlling the allocation for tax purposes.  In addition, the regulations require that the allocation of the deductions match some significant income item attributable to the property securing the nonrecourse debt.  Here there is no apparent match, and so the agreement's allocation of the loss may not control.  Where the agreement does not control, deductions are allocated among the partners based on all the facts and circumstances.  IRC § 704(b).

Part B

If the agreement allocated the loss 50% to Rick, 25% to Sally, and 25% to Tina:

1999:  Rick would face the capital account shortage problem in 1999.  He would be allocated the loss only up to his capital account of $100,000.  The loss would be allocated $100,000 to Rick, $100,000 to Sally, and $100,000 to Tina.

2000:  Due to his lack of a capital account (and absence of an agreement by him to restore a negative capital account), Rick would be allocated none of the loss.  The loss would be allocated $150,000 to Sally, and $150,000 to Tina.

2001:  Here, the agreement would likely control, since the deductions are nonrecourse deductions, and the agreement's allocation of the deductions matches the partners' shares of income.  Thus, the loss would be allocated $150,000 to Rick, $100,000 to Sally, and $100,000 to Tina.

In both parts, the partners' ability to utilize the losses on their individual tax returns could be restricted by the at-risk rules of IRC § 465, or by the passive loss rules of IRC § 469.