704 (c) Flashcards
What is the ceiling rule?
Section 1.704-3(b)(1), which provides that “the total income, gain, loss, or deduction allocated to the partners for a taxable year with respect to a property cannot exceed the total partnership income, gain, loss, or deduction with respect to that property for the taxable year (the ceiling rule).”
Why was 704(c) enacted?
The flexibility engrained in the basic principles of partnership tax can lead to abuse. One such area is the shifting of a partner’s pre-contribution built in gain (or loss) to another partner.
Under section 704(c), a partnership must
make tax allocations concerning property with a built-in gain (or loss) using a reasonable method that is consistent with the purpose of that section. What are the three generally accepted reasonable methods for 704(c) tax allocations?
There are three generally accepted reasonable methods identified in the regulations to account for section 704(c) tax allocations:
(1) the traditional method,
(2) the traditional method with curative allocations, and
(3) the remedial method
What is Section 704 (c) gain?
Each partner’s built-in gain for an item of partnership property.
What is Section 704 (c) capital?
This is equal to the disparity between a partner’s section 704(b) economic entitlement account and tax basis capital account.
What is a forward section 704 (c) layer?
Arises as a result of the contribution of
built-in gain or built-in loss property to a partnership.
What is a reverse section 704 (c) layer?
Created as a result of a revaluation event.
Traditional Method 704 (c), what the computation steps for Built in Gain Property?
1.) Compute Tax Item for an asset for the year (G/L or Dep/Amort)
2.) Compute 704 (b) (Book) Items for the asset
3.) Allocate 704 (b) (Book) Items based on their economic arrangement
4.) Allocate tax item to non contributing partner to the extent of its share of the 704 (b) (Book) items
5.) Allocate residual tax item, if any, to contributing partner
Mechanically speaking how does the ceiling rule work?
Generally, when a non contributing partner is expecting their tax allocation to equal their respective 704 (b) allocation, but due to the tax deduction amount being less than their 704 (b) entitlement, that non contributing partner is ceiling limited by that amount. (I.e. If a NC partner is entitled $10 in 704 (b) depreciation, but is only allocated $8 in tax depreciation for the year, they are considered ceiling rule limited by the difference, which is $2 in this case)
When there is a ceiling rule limitation, what happens to the partners? And what happens over time?
An equal and opposite disparity in each partner’s section 704(c) gain and capital balances is created.
Effectively, ordinary income has
been shifted through the allocation of deductions from the contributor to the noncontributor over time.
