Allocations Flashcards
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What is the ceiling rule?
The partnership may not allocate to the partners more of any tax item than the partnership has actually realized.
Is the same 704(c) method required for all of the partnership’s property?
No. Section 704(c) methods are elected on a property-by-property basis (i.e., the partnership can apply different methods for different property).
What does 704(c) require?
Any BIG or BIL on contributed property must be taken into account by the partnership using any reasonable method. This applies to both sales and depreciation of 704(c) property.
What is the traditional method under 704(c)?
Tax depreciation is allocated to noncontributing partners up to the amount of their share of book depreciation.
Any remaining tax depreciation is allocated to the contributing partner(s).
If the ceiling rule limits allocations, you stop there.
This is the most favorable method for the dirty contributor.
Example:
A and B form partnership AB.
A contributes property with FMV $100 and basis of $60
B contributing $100 cash.
The contributed property has a 10-year recovery period using the straight-line method. Thus, the book depreciation is $10 per year and tax depreciation is $6 per year.
Under the traditional method, B will be allocated tax depreciation up to the full amount of his book depreciation ($5) and A will receive the rest ($1).
If the adjusted basis of the property had been $40, then only $4 of tax depreciation would exist, and thus the partnership is limited by the ceiling rule from allocating to B the full amount of his book depreciation. So, under the traditional method, he would get $4 and A would get none, and then you would stop.
What is the traditional method with curative allocations?
This allows special allocations of similar actual tax items to counteract the ceiling rule limit (but they must actually exist and be of the same character).
This cures the ceiling rule limitation over the remaining life of the property.
This method most favors the non-contributing partners by correcting ceiling rule limitations as quickly as possible (but it is limited to there being available items).
Example:
A and B form partnership AB.
A contributes property with FMV $100 and basis of $40
B contributing $100 cash.
The contributed property has a 10-year recovery period using the straight-line method. Thus, the book depreciation is $5 per year and tax depreciation is $4 per year.
The ceiling rule under the traditional method would limit B’s allocation of tax depreciation to $4, which is $1 less than his book depreciation.
Under the curative method, the partnership can specially allocate an additional $1 of tax depreciation from a similar asset to “cure” the shortfall.
How does the remedial method work?
If tax items are not sufficient to allocate book allocations to noncontributing partner, then “notional” tax items are allocated to noncontributing partner and offsetting notional tax items are created and allocated to contributing partner
Unlike the curative method, this method is not limited by the availability of actual items.
The BIG/BIL asset is hypothetically divided into 2 assets, one with book value equal to tax basis and life equal to actual remaining useful life, and a BIG/BIL asset with $0 tax basis, with a life equal to the useful life as if the asset were net.
Since book basis in excess of tax basis is recovered over 15 years, this provides for recovery over a longer period of time.
This favors the non-contributing partners without regard to available items but may correct ceiling rule limitations over a longer period of time.
So this is actually better for the dirty contributor than the traditional with curative allocations.
For a dirty contributor, what is the optimal order of preference for 704(c) allocations?
Traditional, then remedial (because it corrects ceiling rule distortions over a longer period), then curative (because it correct distortions completely over the life of the asset).
For a non-contributing partner, what is the optimal order of preference for 704(c) allocations?
Curative (because it corrects distortions completely over the shortest period of time, i.e., the life of the asset, although it is limited to actual available similar items).
Remedial (because it corrects over a longer period of time but is not limited to available items).
Traditional (because it does not fully correct).
What method appears most often in partnership agreements?
Traditional - because the non-contributing partners are willing to make this concession to the contributing partner.
What are special allocations?
Special allocations are allocations that differ from the partners’ respective interests in partnership capital.
Are special allocations respected?
They are if they have substantial economic effect. If they don’t, then allocations will be made in accordance with partnership interests.
What is the SEE standard trying to get at?
Whether an allocation is consistent with the underlying economic arrangement.
Usually the concern is allocations of deductions and losses (rather than income).
What is the requirement for substantial economic effect?
Does it have economic effect?
Basic test
Alternative test
Economic Equivalence test
Is it substantial?
No shifting tax consequences
No transitory allocations
What is the basic test for SEE (the Big 3)
Capital accounts have to be maintained in accordance with 1.704-1(b)(2)(iv).
Upon liquidation, distributions have to be made in accordance with positive capital account balances.
If a partner has a deficit capital account after liquidation of their interest, he is unconditionally obligated to restore it by the later of the end of the year or 90 days from liquidation.
What is the alternate test to the basic test?
If the agreement doesn’t have a requirement to restore deficit capital account balances, it will still pass if it has a Qualified Income Offset provision.
This requires that if a partner has a deficit capital account balance as a result of certain unexpected events, the partnership has to allocate him income sufficient to eliminate that deficit as quickly as possible.
