Partnership Taxation

Spring 2006

Bogdanski

FINAL EXAMINATION

(Three hours)

INSTRUCTIONS

This examination consists of three essay questions, each of which will be given equal weight in determining grades. Three hours will be permitted for this examination. At the end of the three hours, you must turn in both this set of essay questions and your answers in the original envelope in which this set came.

All answers must be entered in the bluebooks you have been provided (or, for those operating computers, on separate sheets of plain white paper or an approved type of computer disk). No credit will be given for anything written on this set of questions.

Pay close attention to the final portion, or "call," of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit.

Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.

The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.

Unless otherwise instructed, you should assume that:

" all partners described in the questions are individuals;

" all partners and partnerships described in the questions use the calendar year as their taxable year for federal income tax purposes; and

" all partners and partnerships report their income on the cash method for such purposes.

References to "the Code" are to the Internal Revenue Code of 1986, as amended.

QUESTION ONE

(One hour)

Al, Beth, and Cora form a limited partnership, ABC. Al is the general partner; Beth and Cora are the limited partners. Each partner initially contributes $100,000 cash to ABC in exchange for his or her partnership interest.

The partnership agreement calls for partnership profits and losses to be shared as follows: 50 percent to Al, and 25 percent each to Beth and Cora. No partner is required to restore a deficit in his or her capital account. The partnership agreement contains qualified income offset provisions and minimum gain chargeback provisions that are applicable to all the partners.

ABC borrows $800,000 from a bank on a nonrecourse basis, and uses all of the loan proceeds, plus the partners’ $300,000 contributions, to purchase equipment for future use in its business. The loan is secured by a security interest on the equipment. In the first year of its operations, ABC has gross income of $210,000 and current deductions of $510,000, including $300,000 of depreciation on the equipment. No principal is repaid on the loan in the first year, and ABC makes no distributions to partners.

What are the federal income tax consequences -- to Al, Beth, Cora, and ABC -- of the transactions just described, with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party's basis in the property or interest which that party holds, at each stage of the transactions.

Discuss.

(End of Question 1)

QUESTION TWO

(One hour)

DE is an LLC. It has two members, Dirk and Ella. Under the LLC operating agreement, Dirk and Ella share profits and losses equally. DE makes distributions to Dirk and Ella. Immediately before the distributions, the balance sheet of DE is as follows:

Assets			Liabilities
	Basis	Fair market value		Basis	Fair market value
Cash	$ 150,000	$ 150,000	Debt		-0-
Account receivable	-0-	$ 150,000	Equity
Land held as investment	$ 20,000	$ 100,000	Dirk	$ 85,000	$ 200,000
			Ella	$ 85,000	$ 200,000
Total assets	$ 170,000	$ 400,000	Total liabilities	$ 170,000	$ 400,000

None of the assets were contributed to DE by either partner.

DE distributes to Dirk the accounts receivable. Two weeks later, DE distributes to Ella $150,000 cash. Dirk and Ella retain equal shares of the LLC’s profits and losses before, during, and after the distributions.

Except for any tax consequences of the distributions, DE’s gross income and deductions just happen to offset each other exactly throughout the year.

What are the federal income tax consequences of the distributions -- to Dirk, Ella, and DE -- with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party's basis in the property or interest which that party holds, before and after each distribution.

Explain.

(End of Question 2)

QUESTION THREE

(One hour)

Raja, Samantha, and Tom form a limited partnership, RST, as a holding company for investments. Raja, a professional investment advisor, is the general partner; Samantha, who is a real estate dealer, and Tom, who is a retired fireman, are the limited partners. The partnership agreement, which fully complies with the requirements for “substantial economic effect” contained in the regulations under section 704(b) of the Code, calls for partnership profits and losses to be shared equally among the three partners.

In the formation of RST, Raja transfers to the partnership $100,000 cash in exchange for his partnership interest. In exchange for her partnership interest, Samantha transfers to RST $50,000 cash plus Greenacre, a parcel of undeveloped land, which Samantha has been holding for sale to her real estate customers. Immediately before the transfer, Greenacre has a fair market value of $50,000 and an adjusted basis in Samantha’s hands of $70,000. In exchange for his partnership interest, Tom transfers to RST stock in Bigco, a publicly traded corporation, with a fair market value of $100,000 and an adjusted basis to Tom of $115,000. Before the exchange, Tom has held the Bigco stock for many years.

A few months after it is formed, RST sells the Bigco stock on a national stock exchange for $85,000 cash. About two and a half years later, RST sells Greenacre to a purchaser for $115,000 cash.

What are the federal income tax consequences — to Raja, Samantha, Tom, and RST — of the transactions just described, with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party's basis in the property or interest which that party holds, at each stage of the transactions.

Discuss.

(End of examination)