To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 10 PARTNERSHIPS: FORMATION, OPERATION, AND BASIS SOLUTIONS TO PROBLEM MATERIALS Question/ Problem Learning Objective 10 11 LO LO LO LO LO LO LO LO 3, 7, 11 LO LO LO 12 13 14 15 16 17 18 19 20 21 22 24 LO LO LO LO LO LO 8, LO LO 10 LO 11 LO 11 LO 9, 10 12 LO 4, 6, 7, 9, 10, 11 LO 25 LO 4, 12 23 Topic Status: Present Edition Partnership definition Types of entities treated as partnerships General partnership versus LLP Separately stated items Partnership tax reporting Analysis of Income schedule Entity versus aggregate theory Special allocations Capital accounts Exceptions to § 721 Comparison of corporate and partnership treatment Application of § 721 Disguised sale issue recognition Initial costs of a partnership Partnership’s taxable year Economic effect test Adjustments to partner’s basis Liability allocations to basis Loss limitations Guaranteed payments Self-employment tax Partnership advantages and disadvantages Unchanged New New New Unchanged Unchanged New Unchanged Unchanged New Unchanged Partnership formation and operations issues Formation of partnership; inside and outside basis Formation of partnership; inside and outside basis New Modified New Updated New Unchanged Unchanged Unchanged New Unchanged New Unchanged Q/P in Prior Edition 10 11 14 16 17 18 20 21 New New Instructor: For difficulty, timing, and assessment information about each item, see p 10-4 10-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective 26 LO 27 28 29 LO LO LO 4, 8, 12 30 31 *32 33 34 LO 4, 12 LO 4, 12 LO LO 35 *36 LO 4, 5, 6, LO LO *37 *38 LO 4, 5, LO 39 LO 4, *40 LO *41 LO 7, 8, *42 LO 7, 8, 11 43 LO 7, 8, 10, 11 LO 4, 7, 8, LO 4, 7, 8, LO 7, 8, 9, 10 LO 4, 7, 8, 10 LO 7, 8, 10 LO 7, LO 7, 8, 9, 10 LO 44 45 46 *47 48 49 50 51 Topic Status: Present Edition Q/P in Prior Edition Contribution of various properties on formation of a partnership; basis and depreciation Formation of a partnership Formation of a partnership Basis of property received as gift; receipt of interest for services Planning for service interests Disguised sale versus distribution Treatment of contributed property Tax issues related to formation of partnership Tax issues related to preparation of initial LLC tax return Accounting methods Definition of organization costs; amortization of organization costs Formation of partnership; treatment of costs Computation of partnership’s required tax year under the least aggregate deferral method Date basis of partner’s interest; gain on sale of contributed land with precontribution built-in gain Date basis of partner’s interest; loss on sale of contributed land Computation of partner’s outside basis at beginning and end of year when several transactions took place Partnership income; partner’s basis; separately stated items; guaranteed payments Partnership income; partner’s basis; loss limitations; guaranteed payments Partnership’s income and separately stated items; partner’s basis and amount at risk Same as Problem 44 for an LLC New Unchanged Unchanged 34 35 Unchanged New 36 Updated 38 Updated 39 Basis and loss limitations New Allocations under § 704(b) New Allocation of gain under § 704(b) Allocations under § 704(b) Allocations to partner; basis in interest; loss limitations Allocation of recourse debt New New Unchanged 49 Unchanged 50 Modified Modified Unchanged 26 27 28 Unchanged Unchanged New New 29 30 New New New New Updated 43 Unchanged 44 Instructor: For difficulty, timing, and assessment information about each item, see p 10-4 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis Question/ Problem Learning Objective 52 53 54 LO 4, 8, LO 8, 9, 10, 12 LO 9, 10 55 LO 11 56 LO 11 *57 58 LO 7, 11 LO 11 Topic 10-3 Status: Present Edition Sharing recourse debt for basis purposes Basis calculations and loss limitations Unchanged Unchanged Loss disallowance under § 704(d), § 465, and § 469 Timing of recognition of guaranteed payments Timing of recognition of guaranteed payments, continued Comparison of C corporation salary versus partnership guaranteed payment Disallowed § 267 loss from sale of property to partnership by partner; conversion of capital gain to ordinary income from sale of investment property to partnership by partner New Q/P in Prior Edition 51 52 Updated 54 Unchanged 55 Modified 56 Unchanged 57 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 10-4 Tax Return Problem Topic Status: Present Edition Partnership income tax (Form 1065) Partnership income tax (Form 1065) New Unchanged Economic effect allocations Allocation of liabilities Partnership interest in exchange for services Internet activity Internet activity Internet activity Modified Modified New Unchanged Unchanged Unchanged Q/P in Prior Edition Research Problem 6 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est'd completion time Difficulty Assessment Information AICPA* AACSB* Core Comp Core Comp Easy Easy Easy Easy Easy Medium Easy Easy 10 10 10 10 10 10 10 10 FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting 10 11 12 13 Medium Medium Medium Easy Medium 10 10 10 10 10 14 Medium 10 FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Reporting 15 16 17 18 Medium Easy Easy Medium 10 10 10 10 19 20 21 Medium Easy Medium 10 10 10 22 23 24 Medium Medium Easy 10 15 10 25 Medium 10 26 Easy 10 27 Easy 10 28 Medium 10 29 Hard 15 30 Medium 10 31 Medium 15 32 Medium 15 FN-Reporting FN-Reporting FN-Measurement FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis Question/ Problem Difficulty Est'd completion time 33 Medium 10 34 Medium 15 35 36 Medium Medium 10 10 37 Hard 15 38 39 Medium Medium 10 15 40 Medium 15 41 Medium 20 42 Hard 15 43 Hard 15 44 Medium 15 45 Medium 10 46 Medium 10 47 Medium 15 48 Hard 10 49 Medium 15 50 Medium 15 51 Medium 10 52 Hard 15 53 Medium 15 54 Hard 15 55 Medium 10 56 Medium 10 10-5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic | Reflective Thinking Analytic Analytic Communication | Analytic Analytic Communication | Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-6 2012 Corporations Volume/Solutions Manual Question/ Problem Est'd completion time 57 Difficulty Medium Assessment Information AICPA* AACSB* Core Comp Core Comp 10 FN-Measurement | FNAnalytic Reporting 58 Easy 10 FN-Measurement | FNAnalytic Reporting *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 10-7 CHECK FIGURES 24.a 24.b 24.c 24.d 25.a 25.b 25.c 25.d 25.e 26.a 26.b 26.c 26.d 26.e 26.f 27 28 29.a 29.b 29.c 29.d 30.b 31.a 31.b 31.c 31.d 31.e 31.f 31.g 32.a 32.b 32.c 32.d 33 $0; $0 $300,000 $200,000 $200,000 basis in property ($10,000) realized; $0 recognized $100,000 $110,000 $110,000 Sell and contribute cash $20,000 on land; $90,000 on equipment No gain under § 721 Drew $130,000; Emma $60,000 $80,000 basis in land; $60,000 basis in equipment Inside = Outside = $190,000 Partnership continues Emma’s depreciation schedule No gain or loss to Jared, Chelsea, or partnership; Jared’s basis $85,000; Chelsea’s basis $125,000; partnership’s basis in land $65,000; partnership steps into Chelsea’s shoes for depreciation Chelsea recognizes $25,000 loss on sale; basis is $100,000 Partnership must spend additional $10,000 to acquire assets $0 $50,000 $25,000 ordinary income $75,000 Contribute ‘‘property’’ of ‘‘permits’’ and ‘‘development plan’’ completed before contribution Distribution $0 gain or loss $50,000 Disguised sale $16,667 $66,667 Less likely to be disguised sale if (1) entrepreneurial risk and/or (2) extended time between formation date and distribution Jessica $420,000; Matt $720,000 $200,000 ordinary income $120,000 capital loss and $20,000 ordinary loss All ordinary (>5 years after contribution) Organization costs $12,000 ($5,000 deducted, remainder amortized over 180 months); startup costs $52,000 34 35 36.a 36.b 36.c 37 38 39.a 39.b 39.c 40.a 41.a 41.b 42.a 42.b 42.c 43.a 43.b 43.c 44.a 44.b 44.c ($3,000 deducted, remainder amortized over 180 months); property acquisition costs $18,000 (added to property basis; depreciated as newly acquired asset); syndication costs $$600,000 (nondeductible) Issues include partnership year end; partnership accounting method; treatment of initial costs; partners’ bases in LLC interests; LLC’s basis in property received on formation; interests issued in exchange for services; built-in gain on later sale of land BR can use cash, accrual, or hybrid method in 2009, 2010, and 2011 In 2012 and later years, BR may no longer use cash method Organizational costs: $8,000; syndication costs $10,000 $5,000 deduction plus $50 amortization of organization costs 180-month amortization § 197 intangibles $60,000; § 709 organization cost $2,000; § 195 startup costs $27,800; § 162 expenses $52,800; guaranteed payment $30,000 June 30 $75,000 Five years $15,000 gain $36,000 loss; $30,000 to Reece and remaining $6,000 allocated equally among members $250,000 $385,000 $18,000; long-term capital gain $6,000 $20,000 basis $13,000 basis ($32,000); long-term capital gain $6,000 $0 basis; $11,000 loss deductible currently, $5,000 suspended $0 basis; $4,000 loss allowed; $12,000 suspended $175,000 (Celeste); $125,000 (Christine) Ordinary income $80,000; short-term capital gain $3,000; tax-exempt interest $1,000; charitable contribution $500; distribution to Celeste $20,000 $283,500 basis and at-risk amount © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-8 45.a 45.b 46.a 46.b 46.c 46.d 46.e 47.a 47.b 48.a 48.b 48.c 49.a 49.b 50 2012 Corporations Volume/Solutions Manual Accounts payable are nonrecourse for LLC $283,500 basis; $233,500 amount at risk $60,000 $28,000 $0 $28,000 Dylan can contribute capital or partnership can incur debt Year 1—Bryan $51,200; Cody $72,800 Year 2—Bryan $25,120; Cody $81,280 Yes Gain $43,600 allocated equally Basis—Bryan $46,920; Cody $103,080 Bryan’s cash $46,920; Cody’s cash $103,080 Tax savings now or cash later; not both $87,000 to Chris; $93,000 to Lauren $87,000 to Chris; $63,000 to Lauren Deduct $54,000 of loss unless basis increased before year-end 51 52 53.a 53.b 53.c 53.d 54 55.a 55.b 56 57.a 57.b 58.a 58.b 58.c Melinda $6,000; Gabe $6,000; Pat $18,000 Paul $160,000; Anna $80,000 Basis adjustment rules per Figure 10.3; then loss limitation rules [§ 704(d), § 465, then § 469] $5,000 gain, $0 basis No loss deduction Make distribution next year so Brad can deduct loss this year Partnership can incur additional debt $36,000 deducted; $64,000 suspended ($10,000 under § 704(d); $30,000 under § 465; $24,000 under § 469) $70,000 in 2012, incl guaranteed payment $25,000 in 2012 $70,000 $55,000 salary in 2011 $0 in 2011; $60,000 partnership income and $60,000 guaranteed payment in 2012 $0 $10,000 $80,000 gain; may be ordinary © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 10-9 DISCUSSION QUESTIONS A partnership is an association of two or more persons (including individuals, trusts, estates, corporations, other partnerships, etc.) formed to carry on a trade or business Each partner contributes money, property, labor or skill, and each expects to share in profits and losses The entity must not otherwise be classified as a corporation, trust, or estate p 10-3 The entities treated as a partnership for tax purposes include the general partnership (GP), limited partnership (LP), limited liability company (LLC), limited liability partnership (LLP), and limited liability limited partnership (LLLP) In determining which type of entity to form, the owners consider the type of business operations (e.g., service, manufacturing, real estate, investment, etc.), and the extent to which partner protection from liabilities is required p 10-4 All partners in a general partnership are jointly and severally liable for partnership debts, including liabilities arising from tort or malpractice judgments against the general partnership A general partner bears liability for these debts even if the partner was not personally involved in the malpractice A limited liability partnership (LLP) is generally used by service-providers The LLP is similar to a general partnership, except that the partners’ personal liability is limited Partners in an LLP are only liable for entity liabilities arising from torts committed by the partner or someone supervised by the partner They are not liable for malpractice committed by other partners p 10-4 A separately stated item is any item that might affect the calculation of the tax liability of partners differently In addition, it is an item that might be required to be taken into account in determining a partner’s tax liability For example, long-term capital gains might be taxed at a lower tax rate for one taxpayer than another, and it might be taxed at a different rate than the taxpayer’s other taxable income p 10-5 A partnership is not a tax-paying entity; however, it must still file a tax return The partnership reports its income and expenses on Form 1065 Partnership income is comprised of income from operations and separately stated income and expenses The income and expenses from operating activities are reported on Page of the Form 1065 A separately stated item is any item (income or expense) that could differently affect the tax liabilities of different partners Separately stated items are reported in the partnership return on Schedule K The partners must pay the tax on their respective shares of partnership income The partnership’s income and separately stated items are reported to each partner on a Schedule K-1 prepared for that partner pp 10-5 to 10-7 Because it is not a tax-paying entity, a partnership does not report “taxable income.” However, it must still reconcile between the tax return and the books The partnership prepares the Analysis of Net Income (Loss) (page of Form 1065) to determine what might be called the partnership’s “taxable income equivalent.” Income and deductions shown on Schedule K are netted and entered on the Net Income (loss) line of this Analysis © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-10 2012 Corporations Volume/Solutions Manual This “taxable income equivalent” is reconciled to the partnership’s book income on Schedule M-1 or Schedule M-3 of the partnership’s return This is similar to the corporate reconciliation (also on Schedule M-1 or M-3) in Form 1120; however, for a partnership, the “taxable” amount must be derived as described above pp 10-5 to 10-7 Under the entity concept, the partnership has an existence distinct from its partners This concept gives the partnership its own tax personality As an example, the partnership makes most elections and calculates gains and losses at the partnership level Under the aggregate or conduit concept, a partnership is considered as merely a collection of taxpayers joined in an agency relationship with each other The partnership only accumulates information for the partner As an example, profits and losses from partnership operations flow through to the individual partners for final tax determination Items which might result in different treatment for the partners are shown as separately stated items Many partnership taxation rules contain elements of both entity and aggregate theory concepts p 10-7 and Concept Summary 10.1 A special allocation is an amount that is allocated differently from the general profit or loss sharing ratios specified in the partnership agreement For pre-contribution gain or loss property, special allocations are required to be made to eventually bring the partners’ tax bases in line with their book-value capital accounts Orange, LLC can offer a preferential special allocation of profits and cash flows to Green to compensate the company for use of its capital The LLC can offer a guaranteed payment (rather than a special allocation) to Rose for her managerial time and expertise Upon sale of the appreciated property contributed by Rose, § 704(c) requires the precontribution gain to be allocated to her pp 10-8, 10-26, and 10-39 A partner’s capital account is a mechanical determination of the partner’s financial interest in the partnership, as determined using one of several possible accounting methods, including tax basis, GAAP, § 704(b) book basis, or some other method defined by the partnership The capital account reflects contributions and distributions of cash or other property to or from the partner In addition, it accumulates the partner’s share of increases and decreases from operations, including amounts that are otherwise tax-exempt or nondeductible Even if capital accounts are determined on a tax basis, a partner’s capital account usually will differ from the partner’s basis in the partnership interest because (among other reasons) the capital account does not include the partner’s share of partnership liabilities p 10-9 10 Four situations arise which may result in a taxable gain to one or more of the partners • If property is contributed to an investment partnership, as determined under § 721(b), all built-in gains on transfers to the partnership are recognized by the transferors • If property is contributed to a partnership by two or more parties and that property is later distributed to the other parties in a transaction which appears to be an “exchange” rather than a contribution or distribution, the contribution and distribution are recast as a sale of the properties between the parties © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-20 2012 Corporations Volume/Solutions Manual costs in excess of $50,000 When total costs equal or exceed $55,000, no portion of the expense is currently deductible Instead, the full amount is amortized over 180 months In 2011, TM would deduct $5,156 [$5,000 + ($7,000 × 4/180)] of organizational costs and $4,089 {$3,000 [$5,000 – ($52,000 – $50,000)] + $1,089 [($52,000 – $3,000) × 4/180]} of startup expenses The $18,000 transfer tax is treated as a cost of acquiring the land and is added to the partnership’s basis in the land The $600,000 of brokerage commissions is treated as a syndication cost of the partnership Under §709, these costs cannot be deducted pp 10-16 to 10-18 and Example 20 34 The FC Limited Liability Company must address the following issues in preparing its initial tax return: • What year-end must the LLC use? Unless an election is made under § 444, the LLC must use the year-end determined under the least aggregate deferral method There is no majority member, and the principal members not have the same year-end Under the least aggregate deferral method, the LLC would use a July year-end since this would result in only a 5-month deferral of income to Finch Example 22 • What method of accounting will the LLC use? Even though both members are Subchapter C corporations, the LLC may elect the cash method of accounting if average annual gross receipts are less than $5 million for the year The LLC, then, could select either the cash, accrual, or a hybrid method of accounting p 10-18 • How are the initial legal fees treated? Can the first $5,000 of organizational expenditures be immediately expensed and the balance amortized over a period of 180 months or more? Would any amounts be treated as startup expenditures under § 195? If so, what deduction or amortization is permitted? p 10-16 • The members’ initial bases in their LLC interests must be determined The bases will be the substituted basis of the assets contributed to the LLC ($1.2 million for Finch, and $1.5 million for Cardinal) Example 16 • The LLC’s basis in the property received from the members must be determined, and any cost recovery related to contributed property calculated The LLC takes a basis of $200,000 in the equipment and steps into Finch’s shoes in determining cost recovery allowances Since the licenses and drawings are contributed rather than sold, the LLC takes a $0 basis in these assets, with no cost recovery possible The LLC takes a $500,000 carryover basis in the land and a $2 million basis in the cash p 10-13 • The LLC must determine whether any portion of either of the LLC interests is issued in exchange for services The equipment, cash, and land are considered “property” for purposes of § 721 The building permits and architectural designs also are considered property under § 721, even though they are intangible assets Therefore, none of the LLC interests is issued in exchange for services Example 14 • Treatment of expenses incurred during the initial period of operations must be considered The legal fees are organization costs and their tax treatment was previously noted The construction costs must be capitalized until such time as the building is placed in service The office expense may have to be capitalized under either (1) § 195, if it is determined that the business is still in the startup stage, or (2) § 263A if it is determined the costs © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 10-21 relate to “production” of the rental property If neither of these provisions applies, the office expense is currently deductible pp 10-16 and 10-17 • 35 If the land is later sold, a portion of the gain must be allocated to Cardinal, as the gain was “built-in” at the time the property was contributed For the equipment, depreciation allocations would have to take the precontribution gain into account Allocation of precontribution deductions related to depreciable property are not covered in this text p 10-26 In 2009, 2010, and 2011, BR can use either the cash, accrual, or a hybrid method of accounting BR has at least one Subchapter C corporation as a partner, but BR’s average annual gross receipts did not exceed $5,000,000 in either 2009 or 2010 (BR’s average annual gross receipts were $4,600,000 for 2009 and $4,800,000 for 2010.) In 2012, BR must change to the accrual method of accounting BR has at least one Subchapter C corporation as a partner during that year, and BR’s average annual gross receipts for the preceding year exceeded $5,000,000 (Average annual gross receipts for the period ending in 2011 were $5,200,000.) [Test average annual gross receipts for the 3-year period ending before the current tax year (e.g., 3-year period ending in 2011 for the 2012 tax year).] p 10-18 36 a The legal and accounting fees totaling $8,000 are organizational costs The $10,000 to secure limited partnership investments are nonamortizable, nondeductible syndication costs The $51,500 for advertising and the pre-opening event are startup expenses b The partnership may deduct $5,000 of the organizational costs, plus $50 amortization [($8,000 total – $5,000 deducted)/180 months × months], for a total of $5,050 None of the syndication costs is deductible The partnership may deduct $3,500 of the startup costs [$5,000 maximum permitted – ($51,500 total – $50,000 phaseout)], plus $800 amortization [($51,500 total – $3,500 deducted)/ 180 months × months] [Note that $10,000 of startup expenses is deductible in 2010; this provision may be extended.] c The organizational and startup costs that are not deducted currently are amortized and deducted over 180 months, beginning with the month in which the partnership begins business The syndication costs are not deductible Example 20 37 Section 709 organizational cost; immediate deduction and/or amortization over ≥ 180 months beginning with the month the trade or business begins: Legal fees to form partnership Section 195 “startup cost” immediate deduction and/or amortization over ≥ 180 months beginning with the month the trade or business begins: Advertising for ‘‘Grand Opening” Consulting fees to establish accounting system Pre-opening rent (3 months @ $2,000) Pre-opening utilities (3 months @ $600) Total startup costs $15,000 5,000 6,000 1,800 $27,800 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-22 2012 Corporations Volume/Solutions Manual Section 162 ordinary and necessary business expense: Advertising after opening Rent after opening (3 months @ $2,000) Utilities (3 months @ $600) Salaries to clerks (after opening) Tax return preparation expense Total § 162 expenses $10,000 6,000 1,800 30,000 5,000 $52,800 Section 197 intangible asset, 15-year amortization beginning with the month in which the intangible was acquired Trade name and logo of Granny Newcomb’s, Inc Amortization: $60,000 ÷ 15 yrs ÷ 12 mo × mo = $2,000 Deductible guaranteed payment for services: $30,000 Payments to Carl and Megan ($5,000/month each for three months) (Note that this amount would be capitalized if the expenses were for services during the pre-opening period or for capitalizable services such as architectural consulting, etc.) pp 10-13, 10-16, 10-17, and Example 20 38 June 30 To determine the required tax year of a partnership under the least aggregate deferral method, perform the following steps: • Select one partner’s tax year as a test year • Calculate the number of months from the end of the test year to the next year-end for each partner (i.e., determine the number of deferral months for each partner) • Multiply the number of income deferral months for each partner by each partner’s profit percent • Add the products to determine the aggregate number of deferral months for the test year • Repeat the process until each partner’s tax year has been used as a test year • Compare the aggregate number of deferral months for each test year • The test year that has the smallest number of aggregate deferral months is the required tax year TEST FOR 6/30 YEAR-END (AzureCo’s year-end) Months of Year Ends Profit Interest Deferral Partner AzureCo 6/30 1/2 × = AuburnCo 10/31 1/4 × = AquamarineCo 12/31 1/4 × = Aggregate number of deferral months Product 0.00 1.00 1.50 2.50 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 10-23 TEST FOR 10/31 YEAR-END (AuburnCo’s year-end) Partner Year Ends Profit Interest AzureCo 6/30 1/2 × AuburnCo 10/31 1/4 × AquamarineCo 12/31 1/4 × Aggregate number of deferral months Months of Deferral = = = Product 4.00 0.00 0.50 4.50 = = = Product 3.00 2.50 0.00 5.50 TEST FOR 12/31 YEAR-END (AquamarineCo’s year-end) Partner Year Ends Profit Interest AzureCo 6/30 1/2 × AuburnCo 10/31 1/4 × AquamarineCo 12/31 1/4 × Aggregate number of deferral months Months of Deferral 10 Because 2.50 (for 6/30) is smaller than 4.50 or 5.50 (for 10/31 and 12/31, respectively), the required tax year for the partnership is June 30, under the least aggregate deferral method Example 22 and Figure 10.2 39 a Reece’s basis is $75,000 Under § 722, the basis of an LLC member’s interest equals the adjusted basis of contributed property at the time of contribution Since Reece paid $75,000 for the property, her basis in her LLC interest is $75,000 Example 16 b The LLC’s holding period includes the period during which Reece owned the investment property; thus, Phoenix’s holding period began five years ago p 10-14 c $15,000 gain Under § 704(c), all unrealized gain or loss at the contribution date on property contributed for an LLC interest belongs to the contributing LLC member On the land sale, the LLC realized a gain of $15,000 ($90,000 selling price minus $75,000 adjusted basis) This gain is allocated entirely to Reece, since this was the amount of the unrealized gain on the land at the contribution date Example 30 d Basis Cash $ 90,000 Land 30,000 FMV $ 90,000 180,000 $120,000 $270,000 Interest, Phoebe Interest, Parker Interest, Reece Basis $ 15,000 15,000 90,000* $120,000 FMV $ 90,000 90,000 90,000 $270,000 *$75,000 LLC interest plus $15,000 gain 40 a $36,000 loss Under § 704(c), all unrealized gain or loss at the contribution date on property contributed for an LLC interest belongs to the contributing LLC member Gain or loss in excess of that amount on the subsequent sale or exchange of the property is divided among the LLC members according to their profit and loss sharing ratios On the land sale, the LLC has a loss of $36,000 ($120,000 adjusted basis minus $84,000 selling price), $30,000 of which is allocated to Reece under § 704(c) (Reece’s basis of $120,000 in the land at the contribution date minus the land’s FMV of $90,000 at that date) The remaining loss of $6,000 is allocated equally among the LLC members © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-24 2012 Corporations Volume/Solutions Manual b FMV Cash Land $ 84,000 30,000 Basis $ 84,000 180,000 $114,000 $264,000 FMV $ 13,000 13,000 88,000 $114,000 Interest, Phoebe Interest, Parker Interest, Reece Basis $ 88,000 88,000 88,000 $264,000 Immediately after the sale, each member’s capital account is determined as follows: Before sale Built-in loss on land Loss on land after contribution date After sale Total $150,000 (30,000) Phoebe $15,000 Parker $15,000 Reece $120,000 (30,000) (6,000) $114,000 (2,000) $13,000 (2,000) $13,000 (2,000) $ 88,000 The FMV amount for each member after the sale is determined as follows: Before sale Loss on land after contribution date After sale Total $270,000* Phoebe $90,000 Parker $90,000 Reece $90,000 (6,000) $264,000 (2,000) $88,000 (2,000) $88,000 (2,000) $88,000 *$180,000 FMV of existing land plus $90,000 FMV of Reece’s contribution Example 30 41 a Assuming that Andrea’s capital account reflects an accurate number for basis purposes, her beginning basis is determined as follows: Capital account balance, beginning of year Share of AM’s debt ($100,000 × 1/2) Andrea’s basis, beginning of year b $200,000 50,000 $250,000 Andrea’s basis at the end of the year is determined as follows: Capital account balance, beginning of year $200,000 Add Andrea’s share of: Taxable income Tax-exempt interest income § 1231 gain $160,000 3,000 4,500 Less: Short-term capital loss Political contribution Charitable contribution Cash distribution to Andrea $ 1,000 500 1,000 50,000 Plus: Share of AM’s debt ($140,000 × 1/2) Andrea’s basis, end of year 167,500 $367,500 (52,500) $315,000 70,000 $385,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 10-25 Note that the political contribution decreases her basis even though Andrea cannot deduct the expense Example 37 and Figure 10.3 42 a The partnership’s ordinary taxable income is determined as follows: Sales revenue Cost of sales Depreciation expense Utilities Rent Total ordinary income $150,000 (80,000) (20,000) (14,000) (18,000) $ 18,000 Separately stated items: Long-term capital gain $6,000 The distribution to Lisa is not deductible by the partnership The payment to Mercy Hospital for Kayla’s medical expenses is treated as a distribution to Kayla in the amount of $12,000 Kayla may be able to claim a deduction for medical expenses on her personal tax return b Kayla’s basis in her partnership interest at the end of the tax year is determined as follows, using the ordering rules in Figure 10.3: Beginning basis Share of partnership income Share of separately stated income items: Long-term capital gain Distribution (payment for medical expenses) Ending basis in interest $20,000 9,000* 3,000* (12,000) $20,000 *These items are reported on Kayla’s personal income tax return for the year c Lisa’s basis in her partnership interest at the end of the tax year is determined as follows: Beginning basis Share of partnership income Share of separately stated income items: Long-term capital gain Distribution to Lisa Ending basis in interest $16,000 9,000* 3,000* (15,000) $13,000 *These items are reported on Lisa’s personal income tax return for the year pp 10-21, 10-22, and Example 23 43 a The partnership would report an ordinary loss from operations of $32,000 rather than income of $18,000 (Originally reported receipts were $150,000; revised receipts were $100,000, for a net reduction of $50,000, from $18,000 of income to a $32,000 loss.) Each partner’s share of the loss is $16,000 The separately stated long-term capital gain remains $6,000, with $3,000 being allocated to each partner © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-26 2012 Corporations Volume/Solutions Manual b Kayla’s basis in her partnership interest at the end of the tax year is determined as follows, using the ordering rules in Figure 10.3: Beginning basis Share of separately stated income items: Long-term capital gain Basis before loss allocation and distribution Less: Distribution (partnership payment of medical expenses) Basis before loss allocation Less: Ordinary loss allowed under § 704(d) Ending basis in interest $20,000 3,000 * $23,000 (12,000) $11,000 (11,000)* $ –0– *As in Problem 42, Kayla reports the long-term capital gain The distribution from the partnership is not taxable since it is less than her basis after current income items Her ordinary loss from the partnership is limited under § 704(d) to $11,000 The remaining $5,000 ordinary loss is carried forward until such time as Kayla has sufficient basis in her partnership interest to utilize the loss Example 39 c Lisa’s basis in her partnership interest at the end of the tax year is determined as follows: Beginning basis Share of separately stated income items: Long-term capital gain Basis before loss allocation and distribution Less: Distribution Basis before loss allocation Less: ordinary loss allowed under § 704(d) Ending basis in interest $16,000 3,000 $19,000 (15,000) $ 4,000 (4,000) $ –0– Lisa reports the long-term capital gain Lisa’s basis is $4,000 lower than Kayla’s, and the distribution Lisa received is $3,000 higher than the (indirect) distribution to Kayla, so Lisa’s deductible loss is $7,000 less than Kayla’s Lisa may only deduct $4,000 of the loss The remaining $12,000 loss is carried forward Example 39 and Figure 10.3 44 a Celeste’s beginning basis in her partnership interest is $175,000, calculated as follows: Basis in contributed business-related assets Share of partnership nonrecourse debt Total beginning basis $100,000 75,000 $175,000 Christine’s beginning basis in her partnership interest is $125,000, calculated as follows: Basis in contributed business-related assets Relief of debt assumed by the partnership Share of partnership nonrecourse debt Total beginning basis $200,000 (150,000) 75,000 $125,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis b 10-27 The partnership reports ordinary income of $160,000 Separately stated items include the short-term capital gain ($6,000), tax-exempt interest income ($2,000), and charitable contributions ($1,000) Celeste’s Schedule K-1 shows the following items: Ordinary income Short-term capital gain Tax-exempt interest income Charitable contributions Distribution received by Celeste $80,000 3,000 1,000 500 20,000 On her tax return, Celeste reports the $80,000 of ordinary income on Schedule E She reports the short-term capital gain ($3,000) with her capital transactions on Schedule D She reports the charitable contributions ($500) on Schedule A with her personal charitable contributions The tax-exempt interest income and the distribution she receives are not taxable, although they affect her basis (as shown below) c At the end of the tax year, Celeste’s basis in her partnership interest is $283,500 (including a $70,000 share of partnership nonrecourse debt and a $50,000 share of partnership recourse debt), calculated as follows: Beginning basis Increase in Celeste’s share of recourse debt (50% × $100,000) Decrease in Celeste’s share of nonrecourse debt [50% × ($150,000 – $140,000)] Partnership ordinary income Short-term capital gain Tax-exempt interest income Charitable contributions Distribution to Celeste Ending basis $175,000 50,000 (5,000) 80,000 3,000 1,000 (500) (20,000) $283,500 Celeste’s amount at risk is the same as her basis in the partnership interest, because the nonrecourse debt is qualified nonrecourse financing Example 32 and Figure 10.3 45 a Recourse debts are debts for which at least one partner (or LLC member) has an economic risk of loss Nonrecourse debts are debts for which no partner (or LLC member) has an economic risk of loss Because an LLC limits owner liability to the assets of the entity itself, none of the LLC members are personally liable for the accounts payable of the LLC As such, the accounts payable are treated as nonrecourse debt They are included in the members’ bases in their LLC interests, but they are not included in the amounts at risk Similarly, none of the LLC members are personally liable for the nonrecourse debt of the LLC It is included in the LLC members’ basis (under § 705) as a nonrecourse debt However, as the LLC debt is considered qualified nonrecourse financing, it is included in the amount at risk for purposes of the § 465 limitation b Celeste’s basis in her LLC interest is the same as calculated in 44.c., above— $283,500 This amount includes the same share of LLC liabilities Celeste’s amount at risk in her LLC interest is $233,500 This is $50,000 less than her basis, because her share of ending partnership accounts payable is $50,000 These © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-28 2012 Corporations Volume/Solutions Manual liabilities are nonrecourse debt to the LLC member and are not qualified nonrecourse financing Therefore, they cannot be included in the amount at risk 46 a $60,000 Dylan’s share of last year’s partnership loss is $80,000 ($200,000 × 40%) However, his loss is limited to his basis in the partnership interest, or $60,000 The remaining $20,000 loss is carried forward until such time as Dylan has adequate basis in the partnership to deduct the loss b $28,000 Dylan’s share of the current year partnership income is $48,000 ($120,000 × 40%) He can offset the $20,000 loss carryforward against this amount for net reportable income of $28,000 c Dylan’s basis in the partnership at December 31 of last year is $0 His beginning basis of $60,000 is reduced by the $60,000 loss he utilized last year d Dylan’s basis in the partnership at December 31 of this year is $28,000 His beginning basis of $0 is increased by his $48,000 share of current year income, and reduced by the $20,000 of loss carryforward utilized e At the end of last year, Dylan could have contributed $20,000 of cash to the partnership to ensure his entire loss was deductible Also, (assuming Dylan shares proportionately in partnership liabilities) the partnership could have incurred additional liabilities of $50,000 (A cash flow analysis should be completed to ensure this makes economic sense.) Examples 39 and 40 47 a The partners’ bases at the end of the first year are determined as follows: Capital contribution Loss allocation Depreciation allocation Basis at end of Year Bryan $120,000 (40,000) (28,800) $ 51,200 Cody $120,000 (40,000) (7,200) $ 72,800 The partners’ bases at the end of the second year are determined as follows: Basis at end of Year Income allocation Depreciation allocation Basis at end of Year Bryan $51,200 20,000 (46,080) $25,120 Cody $72,800 20,000 (11,520) $81,280 None of the losses are suspended for either partner, because the initial capital contribution exceeds cumulative profit and loss allocations b These allocations have economic effect because (1) gains, income, loss, etc., allocations are reflected in capital account balances, (2) liquidating distributions are in accordance with ending capital account balances, and (3) deficit capital account balances must be restored pp 10-25 and 10-26 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 48 a 10-29 Gain must be recognized on sale of the equipment: Selling price Less: Adjusted basis Original basis Less: Yr depreciation Less: Yr depreciation Gain $150,000 $200,000 (36,000) (57,600) (106,400) $ 43,600 This gain is reflected in basis as follows: Basis at end of Year Plus: Gain on equipment Basis before final distribution Bryan $25,120 21,800 $46,920 Cody $ 81,280 21,800 $103,080 b Each partner will receive cash from the $150,000 sale proceeds in the amount of the capital account balance reflected above (Bryan gets $46,920 and Cody gets $103,080, for a total of $150,000.) c Bryan has directly reduced his right to cash flows on liquidation in favor of current deductions from taxable income Absent the special allocation of depreciation, the parties would each have received $75,000 on the distribution of sale proceeds The economic effect rules ensure that a deduction reflects a true economic consequence to the partner The partners must decide which is more valuable: the value of a current deduction, or the present value of $1 of cash distributed on termination of the partnership p 10-25 and Example 29 49 a Chris receives $87,000 cash, and Lauren receives $93,000 cash The economic effect test requires that distributions must be in accordance with the positive capital accounts of each partner After the first year of partnership operations, Chris’s capital account is $87,000 [$90,000 + $15,000 (share of income) – $18,000 (share of depreciation)] Lauren’s capital account is $93,000 [$90,000 + $15,000 (share of income) – $12,000 (share of depreciation)] These amounts are consistent with an asset side of the balance sheet that will show $180,000 cash ($30,000 income before depreciation + $150,000 from sale of depreciable asset) b Chris receives $87,000 cash, and Lauren receives $63,000 cash The economic effect test requires that distributions must be in accordance with the positive capital accounts of each partner After the first year of partnership operations, Chris’s capital account is $87,000 (per calculation in a.) Lauren’s capital account is $63,000 [$90,000 + $15,000 (share of income) – $12,000 (share of depreciation) – $30,000 distribution] These amounts are consistent with an asset side of the balance sheet that will show $150,000 of cash ($150,000 from sale of depreciable asset + $30,000 income from operations – $30,000 cash distribution) pp 10-25, 10-26, and Example 29 50 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 September 27, 2011 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-30 2012 Corporations Volume/Solutions Manual Ms Jeanine West Williams Institute of Technology 76 Bradford Lane St Paul, MN 55164 Re: Allocations from the Research Industries Partnership Dear Jeanine: You have asked us to assist you in determining treatment of the expected 2011 results of operations of the Research Industries Partnership (RIP) Allocation RIP is expected to report a loss from operations of $200,000 WIT’s 60% share of this loss is $120,000 The partnership will also report a $100,000 capital gain from sale of land Much of this gain arose before DASH contributed the property to the partnership To that extent, the gain is allocated back to DASH [see § 704(c)(1)(A)] Of the total gain, $40,000 arose after the property was contributed [$300,000 (selling price) – $260,000 (value at contribution date)] Sixty percent of this amount, or $24,000, is allocated to WIT WIT’s basis in the partnership interest at the beginning of the year was $120,000, including the $90,000 share of partnership liabilities All the liabilities were repaid during the year Basis The capital gain and the decrease in liabilities are taken into account before we determine whether any of the loss is deductible WIT’s basis before the loss deduction is determined as follows Beginning basis (1/1/2011) Increase for share of capital gain Decrease in share of partnership liabilities Basis before loss $120,000 24,000 (90,000) $ 54,000 Limitation Unless WIT can increase its basis in the partnership before year-end, WIT will only be able to deduct $54,000 of the $120,000 loss The Company can consider contributing an additional $66,000 cash before year-end Also, the partnership could borrow $110,000 cash on a short-term basis; WIT’s 60% share of this debt would increase its basis so it is adequate for WIT to deduct its full share of RIP’s loss If you have any questions, please not hesitate to contact me Sincerely, Joseph Sanders Instructor Note: The at-risk amount is the same as the general basis limitation under § 704(d), and the loss is not further subject to the passive loss rules since WIT is a material participant in partnership activities Examples 23, 31, and 39 51 This problem has been constructed to yield the same result regardless of whether basis or fair market value numbers are used in the constructive liquidation scenario The allocation of the debt is computed under the constructive liquidation rules The tax basis numbers create the following result: © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis Initial capital Loss on sale of assets Deficit capital Deemed cash contribution Share of debt Melinda $14,000 (20,000) ($ 6,000) 6,000 $ –0– $ 6,000 Gabe $14,000 (20,000) ($ 6,000) 6,000 $ –0– $ 6,000 10-31 Pat $ 2,000 (20,000) ($18,000) 18,000 $ –0– $18,000 The fair market value numbers create the following analysis: Initial capital Loss on sale of assets Deficit capital Deemed cash contribution Share of debt Melinda $19,000 (25,000) ($ 6,000) 6,000 $ –0– Gabe $19,000 (25,000) ($ 6,000) 6,000 $ –0– Pat $ 7,000 (25,000) ($18,000) 18,000 $ –0– $ 6,000 $ 6,000 $18,000 Example 34 52 TAX FILE MEMORANDUM December 8, 2011 FROM: Jane Student SUBJECT: PA Partnership debt allocation Facts: The PA Partnership will be formed before the end of the current year to acquire a $400,000 parcel of land The partnership will be equally owned by Paul and Anna It will purchase the land for $400,000, with $160,000 paid in cash The $240,000 remaining purchase price will be borrowed from First State Bank The loan will be secured by the land, and will be personally guaranteed by both partners The partnership agreement provides that 60% of all income, losses, etc., will initially be allocated to Paul, and the remainder is allocated to Anna Capital accounts will be appropriately maintained under the § 704(b) regulations Any partner with a deficit capital account balance upon liquidation of the partnership will be required to contribute cash in the amount of the deficit at that time Issues: The partners would like to know how the $240,000 debt will be allocated between them for basis purposes Conclusion: Application of the ‘‘constructive liquidation” scenario contained in Reg § 1.752-2 results in an allocation of $160,000 to Paul and $80,000 to Anna Law and Analysis: Under the constructive liquidation scenario, the partnership’s assets are first deemed to be worthless and sold for a loss, which is allocated in accordance with the partnership agreement This would result in a loss of $400,000 on the land, which is allocated 60% to Paul and 40% to Anna, as follows Capital account Loss allocation Ending capital account Paul $ 80,000 (240,000) ($160,000) Anna $ 80,000 (160,000) ($ 80,000) © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-32 2012 Corporations Volume/Solutions Manual The partners each have a negative capital account balance after this allocation, and under the partnership agreement, they would be required to contribute this amount to the partnership upon its liquidation The combined amount would be used to repay the partnership debt of $240,000 The allocation of the debt equals the amount of any liquidating contribution which would go to repay that debt, or $160,000 and $80,000, respectively Instructor Note: In this case, the ending debt allocation does not equal either (1) the proportion of the initial capital contributions by the partners or (2) the allocation of income/loss, etc., under the partnership agreement Example 34 53 a A partner’s basis in the partnership interest must be adjusted in the order shown in Figure 10.3: income items and contributions first increase basis, then basis is reduced by distributions from the partnership Finally, losses may be deducted under § 704(d) to the extent of any remaining basis However, this allowed loss may be further limited under the at-risk and passive loss rules b In Brad’s case, the $20,000 distribution reduces his basis in the partnership interest to $0 and Brad must recognize a $5,000 gain (probably a capital gain) in the amount of the distribution that exceeds his $15,000 basis c Because his basis is reduced to $0, none of the loss can be deducted The full $10,000 is suspended under § 704(d) and must be carried forward until Brad has adequate basis to absorb the loss d If the partnership can make the distribution at the beginning of the following tax year, Brad could deduct the loss in the current year The partnership expects to report earnings in future years, so Brad’s share of that income would increase his basis before the cash is distributed, and he will probably not be required to report a capital gain on the distribution Alternatively, the partnership could incur additional (short-term) debt at the end of the year This approach would be treated as a contribution of capital that increases Brad’s basis in his partnership interest With adequate basis, the cash could be distributed without gain recognition, and the losses would be fully deductible Examples 32, 33, 39, 40, and Figure 10.3 54 TAX FILE MEMORANDUM January 26, 2012 FROM: Beth Mullins SUBJECT: Deductibility of loss from LLC Facts: Jasmine Gregory has the following allocations and bases in her LLC interests for the current year LLC: Income (loss) allocation Basis excluding liabilities Recourse liability allocation Nonrecourse liability allocation Sparrow ($100,000) 50,000 10,000 30,000* Skylark $36,000 N/A N/A N/A © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Partnerships: Formation, Operation, and Basis 10-33 *This debt cannot be treated as qualified nonrecourse debt Jasmine spends significant time working for each LLC during the year Her modified AGI is $300,000 before considering the LLCs’ activities Issues: How much of the $100,000 loss from Sparrow Properties, LLC can Jasmine deduct in the current year? Under what Code provision are any disallowed losses suspended? Conclusion: Jasmine can deduct $36,000 of the $100,000 loss Of the disallowed loss, $10,000 is suspended under § 704(d) An additional $30,000 is suspended under the at-risk limitations The balance, $24,000, is suspended under the passive loss rules of § 469 The special $25,000 deduction for active participation in a passive real estate activity is not available because Jasmine’s modified AGI is too high Law and analysis: Under § 704(d), Jasmine may deduct a portion of the Sparrow loss equal to her basis in her LLC interest, including recourse and nonrecourse liabilities The basis is $90,000 ($50,000 + $10,000 + $30,000), and the excess $10,000 loss is suspended The $30,000 of nonrecourse debt cannot be included in the amount at risk, because it is not qualified nonrecourse indebtedness Therefore, an additional $30,000 is suspended under the at-risk limitation rules of § 465 (After this limitation, $60,000 of the loss is still available for testing under the passive loss limitation rules.) The activities of both LLCs are treated as rental activities, which, by definition, are passive for purposes of § 469 The Sparrow loss is deductible to the extent of the $36,000 of income from Skylark Also, because Sparrow conducts rental real estate activities, and Jasmine is an active participant owning more than 10%, this loss is eligible for an additional $25,000 deduction However, none of this additional $25,000 deduction is available to Jasmine, because her modified AGI exceeds $150,000 (the top of the phaseout range for the additional deduction allowance) Examples 39 and 42 to 44 55 a In its June 30, 2012, tax return, FredCo must report income from F & F of $70,000 This includes FredCo’s $50,000 guaranteed payment, and its 50% distributive share of the partnership’s $40,000 of taxable income for the tax year ended December 31, 2011 b In her December 31, 2012, tax return, Fran must report income from F & F of $25,000 This is her 50% share of the partnership’s $50,000 of taxable income for the tax year ended December 31, 2012 Examples 46 and 47 56 If FredCo’s guaranteed payment increases to $60,000 on January 1, 2012, FredCo’s income for the June 30, 2012, tax year is still $70,000 (as in 55.a above) The increase is reflected as a guaranteed payment on the Schedule K-1 issued for FredCo for the partnership year ended December 31, 2012, and FredCo reports this amount in the June 30, 2013, tax return Examples 46 and 47 57 In addition to recognizing the differences between the entities with respect to the timing of Nicole’s gross income, it is important to use the proper terminology for each item © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-34 2012 Corporations Volume/Solutions Manual a Nicole is taxable on none of the corporation’s taxable income for the year, although the entity is subject to its own income tax She includes the $55,000 salary ($5,000 × 11 months) in her 2011 gross income An employee includes a salary in gross income on the date that he or she receives it b Nicole is taxable on none of the partnership’s income in 2011 Her share of income flows through to her on 1/31/2012, regardless of when the partnership generates the income She includes none of the guaranteed payments in her 2011 income These also are allocated to her on the last day of the entity’s tax year, regardless of when payments are made In 2012, she reports her $60,000 (30%) share of partnership income, plus the $60,000 of guaranteed payments she receives from February 2011 to January 2012 ($5,000 × 12) pp 10-5, 10-39, and Chapter 58 a Zero Section 707(b)(1)(A) applies, and Leah’s $50,000 realized loss is not deductible b $10,000 Section 267(d) permits the partnership to offset any subsequent gain by the loss previously disallowed ($60,000 gain less $50,000 previously disallowed loss) c $80,000 gain Leah’s $80,000 gain would be ordinary under § 707(b)(2) if the investment property immediately after the transfer is not a capital asset of the GRRLs Partnership Examples 51 and 52 The answers to the Research Problems and the Tax Return Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ...To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective 26 LO 27... or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-30 2012 Corporations Volume/Solutions Manual Ms Jeanine West Williams Institute of... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-6 2012 Corporations Volume/Solutions Manual Question/ Problem Est'd completion time 57 Difficulty Medium Assessment