R4-2 Flashcards
Thompson’s basis in Starlight Partnership was $60,000 at the beginning of the year. Thompson materially participates in the partnership’s business. Thompson received $20,000 in cash distributions during the year. Thompson’s share of Starlight’s current operations was a $65,000 ordinary loss and a $15,000 net long-term capital gain. What is the amount of Thompson’s deductible loss for the period?
a.
$55,000
b.
$15,000
c.
$40,000
d.
$65,000
Choice “a” is correct. A partner’s deductible loss is limited to his basis plus any amounts that he is personally liable for (“at risk” provision).
Thompson’s basis would be calculated as follows:
Beginning basis $ 60,000
Plus: Net LT capital gain 15,000
Less: Cash distribution (20,000)
Basis for determining allowable loss deduction $ 55,000
Thompson would be allowed to take a loss deduction for $55,000 of the $65,000 ordinary loss passed through to him from the partnership. The remaining $10,000 would be carried forward until additional basis became available.
Choice “b” is incorrect. This choice assumes a partner can take a loss to the extent of capital gain income.
Choice “c” is incorrect. This choice does not take into account the additional basis Thompson receives for the pass through income (net long-term capital gain).
Choice “d” is incorrect. Thompson’s loss is limited to his basis plus any liabilities that he is personally liable for. His basis is calculated as above for this determination and the question does not indicate he should receive any additional basis for any liabilities.
Stone and Frazier decided to terminate the Woodwest Partnership as of December 31. On that date, Woodwest’s balance sheet was as follows:
Cash $ 2,000
Equipment (adjusted basis) 2,000
Capital - Stone 3,000
Capital - Frazier 1,000
The fair market value of the equipment was $3,000. Frazier’s outside basis in the partnership was $1,200. Upon liquidation, Frazier received $1,500 in cash. What gain should Frazier recognize?
a.
$0
b.
$300
c.
$500
d.
$250
Choice “b” is correct. In a complete liquidation of a partnership, the partner’s basis in property received is the same as the adjusted basis of his partnership interest reduced for any monies actually received and is generally a nontaxable event. However, if a partner receives only money that exceeds his basis in the partnership, gain or loss is recognized. In this instance, Frazier’s basis in his partnership interest was $1,200. He received $1,500 in cash in the liquidation. Frazier’s gain is calculated as follows:
Amount realized $ 1,500
Basis in partnership interest (1,200)
Gain recognized $ 300
Note: Don’t be confused by the term “outside basis.” The term outside basis merely refers to the differences that may exist between the partner’s share of the basis of the assets in the hands of the partnership (inside basis) and his basis in his partnership interest.
Choice “a” is incorrect. If Frazier had received property other than cash, gain would not have been recognized.
Choice “d” is incorrect. This choice appears to utilize Frazier’s book capital of $1,000 (which is wrong) and 50% of the fair market value of the equipment to calculate gain of $500. However, use of that capital balance as his basis and the fact that the question does not indicate that Frazier received anything other than the cash as a distribution make this choice incorrect.
Choice “c” is incorrect. This choice erroneously uses Frazier’s capital on the partnership’s balance sheet as his basis in his partnership.
Barker acquired a 50% interest in Kode Partnership by contributing $20,000 cash and a building with an adjusted basis of $26,000 and a fair market value of $42,000. The building was subject to a $10,000 mortgage, which was assumed by Kode. The other partners contributed cash only. The basis of Barker’s interest in Kode is:
a.
$52,000
b.
$62,000
c.
$41,000
d.
$36,000
Choice “c” is correct. A partner’s basis in a newly formed partnership is determined as follows:
Cash contribution $ 20,000
Adjusted basis of non-cash property 26,000
Share of partnership liabilities assumed by other partners $10,000 × 50% (5,000)
Net total $ 41,000
Choice “d” is incorrect. You must subtract the share of the partnership liabilities assumed by the other partners.
Choice “a” is incorrect. For the contributed property, the fair market value is ignored. The partnership assumes the partner’s adjusted basis. In addition, the share of the partnership liabilities assumed by the other partners is subtracted.
Choice “b” is incorrect. For the contributed property, the fair market value is ignored. The partnership assumes the partner’s adjusted basis.
At partnership inception, Black acquires a 50% interest in Decorators Partnership by contributing property with an adjusted basis of $250,000. Black recognizes a gain if:
I.
The fair market value of the contributed property exceeds its adjusted basis.
II.
The property is encumbered by a mortgage with a balance of $100,000.
a.
Neither I nor II.
b.
II only.
c.
Both I and II.
d.
I only.
Choice “a” is correct. The fair market value of property (high or low) is irrelevant in determining Black’s basis in Decorators. The partner’s adjusted basis is used.
Since the mortgage does not exceed Black’s basis, he will not recognize a gain on the contribution of the encumbered property to Decorators.
On January 4, Year 1, Smith and White contributed $4,000 and $6,000 in cash, respectively, and formed the Macro General Partnership. The partnership agreement allocated profits and losses 40% to Smith and 60% to White. In Year 1, Macro purchased property from an unrelated seller for $10,000 cash and a $40,000 mortgage note that was the general liability of the partnership. Macro’s liability:
a.
Increases Smith’s partnership basis by $16,000.
b.
Has no effect on Smith’s partnership basis.
c.
Increases Smith’s partnership basis by $24,000.
d.
Increases Smith’s partnership basis by $20,000.
Choice “a” is correct. A partner’s basis in the partnership is increased by the partner’s share of partnership liabilities (Smith is a 40% partner). Macro is obligated on the $40,000 mortgage; 40% x $40,000 = $16,000. Even though the partnership is obligated to repay the mortgage, as a partner Smith is jointly and severally liable on the debt.
Choices “d”, “c”, and “b” are incorrect. A partner’s basis in the partnership is increased by the partner’s share of partnership liabilities.
Hart’s adjusted basis in Best Partnership was $9,000 at the time he received the following nonliquidating distributions of partnership property:
Cash $5,000
Land
Adjusted basis 7,000
Fair market value 10,000
What was the amount of Hart’s basis in the land?
a.
$4,000
b.
$7,000
c.
$0
d.
$10,000
Choice “a” is correct. Hart must reduce his $9,000 original basis by the $5,000 cash distribution to a basis of $4,000. Smith’s basis in the land is the lesser of the land’s basis in the partnership’s hands ($7,000) or Hart’s remaining basis in his partnership interest in Best ($4,000 after the cash distribution).
Choice “c” is incorrect. Hart’s basis in the land is greater than zero. Hart’s basis must first be reduced by the cash received.
Choice “b” is incorrect. Hart’s basis in the land can not be greater than his remaining basis in his partnership interest after deducting the cash received.
Choice “d” is incorrect. The fair market value of the land is not considered in determining Hart’s basis in the land.
Stone’s basis in Ace Partnership was $70,000 at the time he received a nonliquidating distribution of partnership capital assets. These capital assets had an adjusted basis of $65,000 to Ace and a fair market value of $83,000. Ace had no unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. What was Stone’s recognized gain or loss on the distribution?
a.
$5,000 capital loss.
b.
$18,000 ordinary income.
c.
$13,000 capital gain.
d.
$0.
Choice “d” is correct. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. The distribution of property with an adjusted basis of $65,000 to Stone from Ace will reduce Stone’s basis in Ace partnership to $5,000 ($70,000 - $65,000). The fair market value of the property (high or low) is not relevant.
Choice “b” is incorrect. The fair market value of the property is not relevant.
Choice “c” is incorrect. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. In addition, the fair market value of the property is not relevant.
Choice “a” is incorrect. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money.
On January 3, Year 1, the partners’ interests in the capital, profits, and losses of Able Partnership were:
% of capital,
profits, and losses
Dean 25%
Poe 30%
Ritt 45%
On February 4, Year 1, Poe sold her entire interest to an unrelated party. Dean sold his 25% interest in Able to another unrelated party on December 20, Year 1. No other transactions took place in Year 1. For tax purposes, which of the following statements is correct with respect to Able?
a.
Able did not terminate.
b.
Able terminated as of December 31, Year 1.
c.
Able terminated as of December 20, Year 1.
d.
Able terminated as of February 4, Year 1.
Choice “c” is correct. Among other events, a partnership terminates for income tax purposes when 50% or more of its interests change hands within 12 months. That threshold was reached for Able on December 20, at which time the partnership terminated for income tax purposes.
Choice “d” is incorrect. On February 4th, only 30% of the interests in the partnership changed hands.
Choice “b” is incorrect. The end of the taxable year is not the termination date, rather it is the date on which the actual sale or other terminating event occurs.
Choice “a” is incorrect. The partnership does terminate when 50% or more of its interests change hands within 12 months.
Curry’s sale of her partnership interest causes a partnership termination. The partnership’s business and financial operations are continued by the other members. What is (are) the effect(s) of the termination?
I.
There is a deemed distribution of assets to the remaining partners and the purchaser.
II.
There is a hypothetical recontribution of assets to a new partnership.
a.
I only.
b.
Neither I nor II.
c.
Both I and II.
d.
II only.
Choice “c” is correct.
Rule: When a partnership is terminated for tax purposes and its remaining partners decide to carry on the partnership business in a (deemed) new partnership, tax law treats this as a distribution of the prior partnership’s assets followed by a recontribution of the (deemed) distributed assets to the new partnership.
Choices “a”, “d”, and “b” are incorrect, per the above rule.
Alt Partnership, a cash basis calendar year entity, began business on October 1, Year 1. Alt incurred and paid the following in Year 1:
Legal fees to prepare the partnership agreement $ 23,000
Accounting fees to prepare the representations in offering materials 15,000
Alt elected to amortize costs. What was the maximum amount that Alt could deduct on the Year 1 partnership return?
a.
$5,300
b.
$4,600
c.
$0
d.
$300
Choice “a” is correct. Eligible expenditures up to $5,000 can be deducted in the first year (with overall limitations). Additional expenditures are amortized over 180 months beginning with the date they begin business. Legal fees to prepare the partnership agreement ($23,000) are eligible for this treatment, but sales and promotional expenses ($15,000) are not deductible or amortizable.
The first year deduction is calculated as follows:
23,000
(5,000) immediate deduction
18,000 / 180 months = $100 per month x 3 = 300 + 5,000 = $5,300
A guaranteed payment by a partnership to a partner for services rendered may include an agreement to pay:
I.
A salary of $5,000 monthly without regard to partnership income.
II.
A 25 percent interest in partnership profits.
a.
I only.
b.
Neither I nor II.
c.
II only.
d.
Both I and II.
Choice “a” is correct.
I.
A guaranteed payment is a salary or other payment to a partner that is not calculated with respect to partnership income.
II.
Since the 25% interest is calculated with respect to partnership profits, it is not a guaranteed payment.
Choices “c”, “d”, and “b” are incorrect, per the above explanation.
Curry’s adjusted basis in Vantage Partnership was $5,000 at the time he received a nonliquidating distribution of land. The land had an adjusted basis of $6,000 and a fair market value of $9,000 to Vantage. What was the amount of Curry’s basis in the land?
a.
$6,000
b.
$5,000
c.
$9,000
d.
$1,000
Choice “b” is correct. A partner who receives a distribution of non-cash property from a partnership takes the partnership’s basis as his basis, but in no case an amount greater than his basis in his partnership interest. In this case Curry would ordinarily take a $6,000 basis in the land, but since his basis in the partnership interest is only $5,000, that is the basis of the land in his hands. Curry’s partnership interest now has a basis of zero.
Choices “c”, “a”, and “d” are incorrect. Each of these uses the wrong basis (the basis a partner takes in a nonliquidating distribution).
White has a one-third interest in the profits and losses of Rapid Partnership. Rapid’s ordinary income for the current taxable year is $30,000, after a $3,000 deduction for a guaranteed payment made to White for services rendered. None of the $30,000 ordinary income was distributed to the partners. What is the total amount that White must include from Rapid as taxable income in his current year tax return?
a.
$11,000
b.
$3,000
c.
$10,000
d.
$13,000
Choice “d” is correct.
Rule: Partnership income is taxable to a partner whether or not it is distributed. White’s share of Rapid’s income is the sum of the $3,000 guaranteed payment and one-third of the partnership’s net income of $30,000 ($10,000), for a total of $13,000.
Choices “b”, “c”, and “a” are incorrect, per the above rule.
On January 2, Year 1, Black acquired a 50% interest in New Partnership by contributing property with an adjusted basis of $7,000 and a fair market value of $9,000, subject to a mortgage of $3,000. What was Black’s basis in New at January 2, Year 1?
a.
$7,500
b.
$5,500
c.
$4,000
d.
$3,500
Choice “b” is correct. A contributing partner’s basis is the adjusted basis of assets contributed, plus any gain recognized on the contribution, less debt relief.
Basis $ 7,000
Debt relief ($3,000 x 50%) (1,500)
Basis $ 5,500
Choices “d”, “c”, and “a” are incorrect. A contributing partner’s basis is the adjusted basis of assets contributed, plus any gain recognized on the contribution, less debt relief.
Gray is a 50% partner in Fabco Partnership. Gray’s tax basis in Fabco at the beginning of the year was $5,000. Fabco made no distributions to the partners during the year and recorded the following:
Ordinary income $ 20,000
Tax exempt income 8,000
Portfolio income 4,000
What is Gray’s tax basis in Fabco at the end of the year?
a.
$10,000
b.
$21,000
c.
$16,000
d.
$12,000
Choice “b” is correct. A partner’s basis is increased by the partner’s share of partnership ordinary income, separately stated income, and tax exempt income. $5,000 + 50% x ($20,000 + $8,000 + $4,000) = $21,000.
Choice “c” is incorrect. Gray’s basis is increased by $16,000, but the question asks what his total basis is at the end of the year.
Choice “d” is incorrect. Gray’s basis is increased by 50% of $20,000 + $4,000, or $12,000, but it is also increased by 50% of tax exempt income. This increase is added to the beginning tax basis.
Choice “a” is incorrect. Gray’s basis is increased by 50% of ordinary income or $10,000, but it is also increased by tax exempt and portfolio income. This increase is added to the beginning tax basis.
On January 2, Year 1, Arch and Bean contribute cash equally to form the JK Partnership. Arch and Bean share profits and losses in a ratio of 75% to 25%, respectively. For Year 1, the partnership’s ordinary income was $40,000. A distribution of $5,000 was made to Arch during Year 1. What is Arch’s share of taxable income for Year 1?
a.
$5,000
b.
$10,000
c.
$20,000
d.
$30,000
Choice “d” is correct. Partners are taxed on their share of partnership income whether distributed or not. Arch must report 75% x $40,000, or $30,000.
Choice “a” is incorrect. Partners are taxed on their share of partnership income, not distributions.
Choice “b” is incorrect. Arch has a 75% ownership interest.
Choice “c” is incorrect. Arch and Bean have a 75-25 profit (loss) ratio, not 50-50.
Guaranteed payments made by a partnership to partners for services rendered to the partnership, that are deductible business expenses under the Internal Revenue Code, are:
I.
Deductible expenses on the U.S. Partnership Return of Income, Form 1065, in order to arrive at partnership income (loss).
II.
Included on schedules K-1 to be taxed as ordinary income to the partners.
a.
Neither I nor II.
b.
Both I and II.
c.
I only.
d.
II only.
Choice “b” is correct. Guaranteed payments to partners are deductible on Form 1065, Line 10, to arrive at partnership ordinary income. On Schedule K-1, guaranteed payments are shown as income on Line 5 and flow through as ordinary income.
Choices “c”, “d”, and “a” are incorrect. Each of these does not address both rules correctly.
At the beginning of the taxable year, Paul owned a 25% interest in Associates partnership. During the year, a new partner was admitted and Paul’s interest was reduced to 20%. The partnership liabilities at January 1 were $150,000 but decreased to $100,000 at December 31. Paul’s and the other partners’ capital accounts are in proportion to their respective interests. Disregarding any income, loss or drawings for the taxable year, the basis of Paul’s partnership interest at December 31 compared to the basis of his interest at January 1 was:
a.
Decreased by $37,500.
b.
Decreased by $5,000.
c.
Increased by $20,000.
d.
Decreased by $17,500.
Choice “d” is correct. Paul’s partnership interest consists of his capital plus his share of liabilities. Paul’s share of liabilities on January 1 was 25% x $150,000, or $37,500. On December 31 Paul’s share was 20% x $100,000, or $20,000; a decrease during the year of $17,500.
Choices “a”, “c”, and “b” are incorrect. Paul’s basis in his partnership interest consists of his capital account plus his share of liabilities.
Day’s adjusted basis in LMN Partnership interest is $50,000. During the year Day received a nonliquidating distribution of $25,000 cash plus land with an adjusted basis of $15,000 to LMN and a fair market value of $20,000. How much is Day’s basis in the land?
a.
$20,000
b.
$25,000
c.
$15,000
d.
$10,000
Choice “c” is correct. In a nonliquidating distribution, the partner takes the partnership basis for assets distributed. This basis cannot exceed the partner’s partnership interest.
Choice “d” is incorrect. This is Day’s remaining basis in the partnership, not the basis for the land.
Choices “a” and “b” are incorrect. In a nonliquidating distribution, the partner takes the partnership basis for assets distributed.
Pert contributed land with a fair market value of $20,000 to a new partnership in exchange for a 50% partnership interest. The land had an adjusted basis to Pert of $12,000 and was subject to a $4,000 mortgage, which the partnership assumed. What is the adjusted basis of Pert’s partnership interest?
a.
$18,000
b.
$10,000
c.
$12,000
d.
$20,000
Choice “b” is correct. Pert’s adjusted basis in the partnership is equal to the $12,000 adjusted basis of the land he contributed to the partnership less the 50% allocable percentage of the $4,000 mortgage assumed by the other partners.
Land basis $ 12,000
50%* × $4,000 mortgage (2,000)
Pert’s basis in the partnership $ 10,000
* Other partners’ percentage ownership
Choice “c” is incorrect. The amount of the liability assumed by the other partners must be subtracted from the adjusted basis.
Choice “a” is incorrect. Use the land’s $12,000 adjusted basis as the starting point, not its $20,000 fair market value.
Choice “d” is incorrect. Use the land’s $12,000 adjusted basis as the starting point, not its $20,000 fair market value, and subtract the percentage of the liability assumed by the other partners.
The method used to depreciate partnership property is an election made by:
a.
The “principal partner.”
b.
The partnership and may be any method approved by the IRS.
c.
The partnership and must be the same method used by the “principal partner.”
d.
Each individual partner.
Choice “b” is correct. Under entity theory, the partnership elects the depreciation method to be used and may use any method approved by the IRS.
Choice “c” is incorrect. The method need not be the same as that used by the principal partner.
Choice “a” is incorrect. The election is not made by the principal partner.
Choice “d” is incorrect. The election is not made by each individual partner.
Under Section 444 of the Internal Revenue Code, certain partnerships can elect to use a tax year different from their required tax year. One of the conditions for eligibility to make a Section 444 election is that the partnership must:
a.
Choose a tax year where the deferral period is not longer than three months.
b.
Have less than 75 partners.
c.
Be a limited partnership.
d.
Be a member of a tiered structure.
Choice “a” is correct. Sec. 444 permits a partnership to elect a tax year different from the required tax year if the deferral period (i.e., the number of months between the beginning of the tax year and the end of the required tax year) is 3 months or less.
Choice “c” is incorrect. The partnership need not be a limited partnership.
Choice “d” is incorrect. The partnership need not be a member of a tiered structure.
Choice “b” is incorrect. The partnership need not have less than 75 partners.
In computing the ordinary income of a partnership, a deduction is allowed for:
a.
Guaranteed payments to partners.
b.
Contributions to recognized charities.
c.
Short-term capital losses.
d.
The first $100 of dividends received from qualifying domestic corporations.
Choice “a” is correct. Guaranteed payments to partners are deductible in arriving at the partnership’s ordinary income. Ordinary income is the “taxable income” of the partnership excluding all items required to be separately-stated. Charitable contributions, dividend income, and capital losses are all separately-stated items.
Choice “b” is incorrect. Charitable contributions are not deducted to arrive at ordinary income. They are a separately stated item.
Choice “d” is incorrect. Dividend income is not deducted to arrive at ordinary income. It is a separately stated item.
Choice “c” is incorrect. Net short-term capital losses are not deducted to arrive at ordinary income. They are a separately stated item.
When a partner’s share of partnership liabilities increases, that partner’s basis in the partnership:
a.
Increases by the partner’s share of the increase.
b.
Decreases by the partner’s share of the increase.
c.
Is not affected.
d.
Decreases, but not to less than zero.
Choice “a” is correct. When a partner’s share of partnership liabilities increases, that partner’s basis in the partnership increases by his share of the increase. Since the partner has unlimited liability, the partnership liabilities are treated as if the partner personally borrowed the money and then contributed it to the partnership.
Choice “b” is incorrect. It increases, not decreases, the partner’s basis by his share of the increase in the liabilities.
Choice “d” is incorrect. It increases, not decreases, the partner’s basis by his share of the increase in the liabilities.
Choice “c” is incorrect. The partner’s basis is affected; it increases by the partner’s share of the increase in liabilities.
Cobb, Danver, and Evans each owned a one-third interest in the capital and profits of their calendar-year partnership. On September 18, Year 5, Cobb and Danver sold their partnership interests to Frank and immediately withdrew from all participation in the partnership. On March 15, Year 6, Cobb and Danver received full payment from Frank for the sale of their partnership interests. For tax purposes, the partnership:
a.
Terminated on September 18, Year 5.
b.
Did not terminate.
c.
Terminated on March 15, Year 6.
d.
Terminated on December 31, Year 5.
Choice “a” is correct. A partnership terminates for tax purposes if within a 12-month period there is a sale or exchange of at least 50% of the total interest in partnership capital and profits. In this case, the partnership terminates September 18, Year 5, the date that 2/3 interest in the partnership is sold to new partner Frank.
Choice “d” is incorrect. The partnership terminated on the date that at least 50% of the partnership interest was sold, not the end of the partnership year in which the sale occurred.
Choice “c” is incorrect. The partnership terminated on the date that at least 50% of the partnership interest was sold, not the date of full payment between the old and new partners.
Choice “b” is incorrect. The partnership terminated on the date that at least 50% of the partnership interest was sold.
On June 30, Year 8, Berk retired from his partnership. At that time, his capital account was $50,000 and his share of the partnership’s liabilities was $30,000. Berk’s retirement payments consisted of being relieved of his share of the partnership liabilities and receipt of cash payments of $5,000 per month for 18 months, commencing July 1, Year 8. Assuming Berk makes no election with regard to the recognition of gain from the retirement payments, he should report income therefrom of:
~Year 8
~Year 9
a.
$20,000
$20,000
b.
–
$40,000
c.
$40,000
–
d.
$13,333
$26,667
Choice “b” is correct. Payments made in liquidation of the interest of a retiring partner are considered a distribution by the partnership. Therefore, a retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions:
Berk’s partnership basis on 6/30/Yr 8 $ 80,000
$5,000 x 6 months, Year 8 cash distributions nontaxable, basis reduction (30,000)
Relief of debt (30,000)
Berk’s partnership basis on 12/31/Yr 8 20,000
$5,000 x 12 months, Year 9 distributions (60,000)
Negative basis (40,000)
Capital gain to eliminate negative basis 40,000
Berk’s basis on 12/31/Yr 9, liquidated $ 0
Choices “d”, “a”, and “c” are incorrect. Payments made in liquidation of the interest of a retiring partner are considered a distribution by the partnership. Therefore, a retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions.
Owen’s tax basis in Regal Partnership was $18,000 at the time Owen received anonliquidating distribution of $3,000 cash and land with an adjusted basis of $7,000 to Regal and a fair market value of $9,000. Regal did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. Disregarding any income, loss, or any other partnership distribution for the year, what was Owen’s tax basis in Regal after the distribution?
a.
$7,000
b.
$8,000
c.
$6,000
d.
$9,000
Choice “b” is correct. In a nonliquidating distribution, the partner’s basis is reduced first by the amount of cash received and then by the adjusted basis of any property received. Thus, Owen’s basis after the distribution is determined as follows:
Owen’s beginning basis $ 18,000
Cash received (3,000)
Basis of property received (7,000)
Owen’s adjusted basis after the distribution $ 8,000
Choices “d”, “a”, and “c” are incorrect, per the above explanation.
Bailey contributed land with a fair market value of $75,000 and an adjusted basis of $25,000 to the ABC Partnership in exchange for a 30% interest. The partnership assumed Bailey’s $10,000 recourse mortgage on the land. What is Bailey’s basis for his partnership interest?
a.
$18,000
b.
$65,000
c.
$15,000
d.
$75,000
Choice “a” is correct.
A partner’s original basis for a partnership interest acquired by a contribution is the amount of cash plus the adjusted basis of any property contributed less the amount of incoming partner’s liabilities assumed by the other partners. Bailey’s basis is calculated as follows:
Adjusted basis of property contributed $ 25,000
Less: The amount of Bailey’s debtassumed by the other partners (70% of $10,000) (7,000)
Bailey’s basis $ 18,000
Choices “c”, “b”, and “d” are incorrect, per the above explanation.
A partnership had four partners. Each partner contributed $100,000 cash. The partnership reported income for the year of $80,000 and distributed $10,000 to each partner. What was each partner’s basis in the partnership at the end of the current year?
a.
$120,000
b.
$117,500
c.
$110,000
d.
$170,000
RULE: The basis in a partnership is increased by investment, pro-rata share of income, and liabilities for which the partner is personally liable. The basis of a partnership is decreased by distributions, pro-rata share of losses, and liabilities for which the partner is personally relieved of.
Choice “c” is correct. Per the above rule, each partner’s basis in the partnership is $110,000 at the end of the current year, calculated as follows:
Contributions$100,000
Pro-rata income allocation
20,000
[$80,000 / 4 partners]
Pro-rata income allocation
(10,000)
Basis at year-end
$110,000
Choice “d” is incorrect. The partnership reported income of $80,000, and this amount must be allocated pro-rata to each partner. The mistake made here is that the entire $80,000 was included for each partner as an increase in basis when it should only have been ¼ of that amount (or $20,000). Applying all other facts correctly, this answer was calculated as $100,000 + $80,000 - $10,000 = $170,000.
Choice “a” is incorrect. The distribution of $10,000 must be deducted from the basis of each partner. Applying all other facts correctly, this answer was calculated as $100,000 + $20,000 = $120,000.
Choice “b” is incorrect. Each partner received a distribution of $10,000. Therefore, the total distributions for the partnership were $40,000. The mistake made here was that the $10,000 distribution was incorrectly assumed to be the total distribution made by the partnership. $10,000 divided by 4 = $2,500. Applying all the other facts correctly, this answer was calculated as $100,000 + $20,000 - $2,500 = $117,500.
Kerr and Marcus form KM Partnership with a cash contribution of $80,000 from Kerr and a property contribution of land from Marcus. The land has a fair market value of $80,000 and an adjusted basis of $50,000 at the date of the contribution. Kerr and Marcus are equal partners. What is Marcus’s basis immediately after formation?
a.
$50,000
b.
$0
c.
$80,000
d.
$65,000
RULE: Generally, no gain or loss is recognized on the contribution of property to a partnership in return for a partnership interest. The basis of the partnership interest is the basis of the property in the hands of the partner upon contribution. The partnership takes on the contributor’s basis of the contributed property; however, if the fair market value of the property differs from the basis, the amount of the unrealized gain or loss at the date of contribution is specially allocated to the contributing partner upon the sale of that contributed property.
Choice “a” is correct. Per the above rule, Marcus’ basis in the partnership immediately after formation is $50,000, which is Marcus’ basis in the land at the date of contribution.
Choice “b” is incorrect. Marcus has a basis in the partnership in the amount of Marcus’ basis in the property upon contribution.
Choice “d” is incorrect. Per the above rule, Marcus’ basis in the partnership immediately after formation is $50,000, which is Marcus’ basis in the land at the date of contribution.
Choice “c” is incorrect. Per the above rule, Marcus’ basis in the partnership immediately after formation is $50,000, which is Marcus’ basis in the land at the date of contribution. The basis is not the fair market value at the date of contribution.
Smith received a one-third interest of a partnership by contributing $3,000 in cash, stock with a fair market value of $5,000 and a basis of $2,000, and a new computer that cost Smith $2,500. Which of the following amounts represents Smith’s basis in the partnership?
a.
$7,500
b.
$5,500
c.
$3,000
d.
$10,500
Rule: Generally, no gain or loss is recognized on the contribution of property to a partnership in return for partnership interest. The basis of the partnership interest is the basis of the property in the hands of the partner upon contribution. The partnership takes on the contributor’s basis of the contributed property; however, if the fair market value of the property differs from the basis, the amount of the unrealized gain or loss at the date of contribution is specially-allocated to the contributing partner upon the sale of that contributed property.
Choice “a” is correct. Applying the rule above, Smith’s basis in the partnership upon contribution is calculated as follows:
Cash contributed $ 3,000
Basis of stock contributed 2,000
Basis of computer contributed 2,500
Basis in partnership $ 7,500
Choice “d” is incorrect. This answer assumes that the fair market value of the stock ($5,000) is used to calculate the basis of the partnership, but this is an incorrect assumption (the basis of $2,000 is used).
Choice “b” is incorrect. This answer neglected to include in the basis of the partnership the $2,000 basis of the stock contributed.
Choice “c” is incorrect. This answer neglected to include in the basis of the partnership the property contributed to the partnership and only considered the cash contributed.
Walker transferred property used in a sole proprietorship to the WXYZ partnership in exchange for a one-fourth interest. The property had an original cost of $75,000, an adjusted tax basis to Walker of $20,000, and fair market value of $50,000. The partnership has no liabilities. What is Walker’s basis in the partnership interest?
a.
$0
b.
$50,000
c.
$20,000
d.
$75,000
Choice “c” is correct. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest. The partner’s original basis for a partnership interest acquired by contribution of property is the adjusted tax basis of the property (unless the property is subject to excess liability, which is not the case in this question).
Choice “a” is incorrect. Walker’s adjusted tax basis in the property is $20,000. There are no partnership liabilities, and the facts do not indicate that the property was subject to excess liability. The facts in the question do not support a zero basis in the partnership interest.
Choice “b” is incorrect. The $50,000 fair market value is not used to determine the initial basis in the partnership interest; however, upon the sale of the property, the fair market value will be used in the calculation of the special allocation to the contributing partner of the built-in gain on the sale.
Choice “d” is incorrect. The $75,000 original cost of the property is not used to determine the contributing partner’s basis. The amount to use is the adjusted tax basis (cost less depreciation or other basis reduction) upon contribution.
Olson, Wayne, and Hogan are equal partners in the OWH partnership. Olson’s basis in the partnership interest is $70,000. Olson receives a liquidating distribution of $10,000 cash and land with a fair market value of $63,000, and a basis of $58,000. What is Olson’s basis in the land?
a.
$63,000
b.
$60,000
c.
$70,000
d.
$58,000
Choice “b” is correct.
In a liquidating distribution, the partner’s basis for the distributed property is the same as the adjusted basis of his partnership interest (as the partner is simply exchanging his partnership interest for the distributed assets), reduced by any monies received in the same transaction.
Olson’s basis before distribution $70,000
Less: Cash received (10,000)
Remaining basis in partnership 60,000
Less: Allocate basis to land (60,000)
Liquidated partnership basis $ 0
Choice “d” is incorrect. This would be the answer if the distribution were a non-liquidating distribution (which would then mean that partner would still have a partnership interest with a basis of $2,000 ($60,000 - $58,000 land basis).
Choice “a” is incorrect. The fair market value of the asset is not considered in a liquidation.
Choice “c” is incorrect. The allocable basis must first be reduced by the amount of cash received.
The at-risk limitation provisions of the Internal Revenue Code may limit:
I.
A partner’s deduction for his or her distributive share of partnership losses.
II.
A partnership’s net operating loss carryover.
a.
II only.
b.
Both I and II.
c.
Neither I nor II.
d.
I only.
Choice “d” is correct. A partner’s tax deduction for his or her distributive share of partnership losses is limited to the partner’s adjusted basis in the partnership, which is increased by any partnership liabilities that he or she is personally liable for (called the “at-risk” provision). Any unused loss can be carried forward and used in a future year when basis becomes available; therefore, the at-risk limitation does not limit a partner’s net operating loss carryover.
Choices “a”, “b”, and “c” are incorrect, based on the above discussion.
On December 31, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all liabilities. On that date, the adjusted basis of Clark’s partnership interest was $40,000, consisting of his capital account of $15,000 and his share of the partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark’s gain or loss on the sale of his partnership interest?
a.
Capital gain of $15,000.
b.
Ordinary gain of $15,000.
c.
Ordinary loss of $10,000.
d.
Capital loss of $10,000.
Choice “a” is correct. A partner who sells his interest in a partnership has a recognized gain or loss that is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest. If there are any partnership liabilities allocated to the interest and transferred to the buyer, they are considered part of the amount realized. Any gain that represents a partner’s share of “hot assets” (unrealized receivables of appreciated inventory) is treated as ordinary income if cash is taken. Clark’s capital gain on the sale is calculated as follows:
Amount realized on the sale:
Cash $ 30,000
Liabilities relieved of 25,000 55,000
Less: Basis in the partnership (40,000)
Capital gain on sale* $ 15,000
* Note: The facts tell us that the partnership had no unrealized receivables or substantially appreciated inventory; therefore, there are no “hot assets” to cause Clark to categorize any of the gain as ordinary income. The entire gain is capital gain.
Choice “c” is incorrect. This answer option incorrectly excludes the partnership liabilities that Clark is relieved of as part of the amount realized [$30,000 cash received - $40,000 basis = $10,000 loss]. Further, as the partnership has no unrealized receivables or appreciated inventory, ordinary income recognition is not applicable.
Choice “b” is incorrect. This answer option correctly calculates the gain on the sale as $15,000, but it incorrectly categorizes the gain as ordinary, when there are no unrealized receivables or appreciated inventory items that would cause ordinary income recognition to be applicable.
Choice “d” is incorrect. This answer option incorrectly excludes the partnership liabilities that Clark is relieved of as part of the amount realized [$30,000 cash received - $40,000 basis = $10,000 loss]. However, the classification of the gain as capital is correct because the partnership has no unrealized receivables or appreciated inventory that would cause ordinary income recognition to be applicable.
Reid, Welsh, and May are equal partners in the RWM partnership. Reid’s basis in the partnership interest is $60,000. Reid receives a liquidating distribution of $61,000 cash and land with a fair market value of $14,000 and an adjusted basis of $12,000. What gain must Reid recognize upon the liquidation of his partnership interest?
a.
$13,000
b.
$1,000
c.
$15,000
d.
$0
Choice “b” is correct. With a liquidating distribution, the partner’s basis for the distributed property is the same as the adjusted basis of his partnership interest, first reduced by any monies received. The partner will recognize gain only to the extent that money received exceeds the partner’s basis in the partnership.
Basis before liquidating distribution $ 60,000
Less: Cash received (61,000)
Cash received in excess of basis (1,000)
Gain to be recognized 1,000
Basis after gain recognition $ 0
Note: The basis of the land to Reid is zero, as Reid has no remaining basis in the partnership to allocate to the land (i.e., Reid has exchanged his entire interest in the partnership for the cash and the land).
Choice “d” is incorrect. Gain is recognized because the cash received exceeded the basis in the partnership before the liquidation.
Choice “a” is incorrect. This answer option incorrectly assumes that the adjusted basis of the land reduced the basis in the partnership before the cash received reduced the basis. As mentioned above, cash received must first reduce the basis before any allocation of basis can be made to the remaining non-cash property [$60,000 - $12,000 = $48,000; $48,000 - $61,000 = ($13,000) in excess of basis].
Choice “c” is incorrect. This answer option incorrectly assumes that the fair market value of the land (fair market value would not be used even if cash were not received, however) reduced the basis in the partnership before the cash received reduced the basis. As mentioned above, cash received must first reduce the basis before any allocation of basis can be made to the remaining non-cash property [$60,000 - $14,000 = $46,000; $46,000 - $61,000 = ($15,000) in excess of basis].
Baker is a partner in BDT with a partnership basis of $60,000. BDT made a liquidating distribution of land with an adjusted basis of $75,000 and a fair market value of $40,000 to Baker. What amount of gain or loss should Baker report?
a.
$20,000 loss.
b.
$35,000 loss.
c.
$15,000 gain.
d.
$0
Choice “d” is correct. In a complete liquidation of a partnership, a partner (Baker) recognizes gain only to the extent that the money received (if any) exceeds that partner’s adjusted basis in the partnership immediately before the distribution. In this question, there is no money distributed, so there is no gain. The partner recognizes loss if only money, unrealized receivables, or inventory are received and if the basis of the assets received is less than the partner’s basis in the partnership. In this question, there is no money, unrealized receivables, or inventory distributed, so there is no loss, regardless of the partner’s basis in the partnership. Even though the land has a $40,000 fair market value, Baker’s basis in the land is his $60,000 partnership basis, effectively giving him a $20,000 built-in loss that he can recognize by selling the land.
Choice “b” is incorrect. The $35,000 is the difference between the $40,000 fair market value of the land and the land’s $75,000 adjusted basis (to the partnership). That difference is not reported as a loss by the partner or by the partnership.
Choice “a” is incorrect. The $20,000 is the difference between the $40,000 fair market value of the land and the $60,000 partner’s adjusted basis in the partnership. That amount is the partner’s built-in loss in the land, but the loss is not recognized unless and until the partner sells or disposes of the land in a separate taxable transaction.
Choice “c” is incorrect. The $15,000 is the difference between the $60,000 partner’s adjusted basis in the partnership and the $75,000 partnership’s adjusted basis in the land. That difference is not recognized in any way.
Nolan designed Timber Partnership’s new building. Nolan received an interest in the partnership for the services. Nolan’s normal billing for these services would be $80,000 and the fair market value of the partnership interest Nolan received is $120,000. What amount of income should Nolan report?
a.
$80,000
b.
$120,000
c.
$0
d.
$40,000
Choice “b” is correct. In this question, Nolan receives an interest in the partnership for services performed. The services are valued at the fair market value of what is received (the partnership interest) of $120,000, regardless of what Nolan’s normal billing for these services might have been.
Choice “c” is incorrect. Nolan would certainly report some income from the services that she performed when something is received in return for those services.
Choice “d” is incorrect. The $40,000 is the difference between the fair market value of the partnership (and of the services performed) and Nolan’s billing. That number is meaningless in this question.
Choice “a” is incorrect. The $80,000 is Nolan’s normal billing for her services. However, her income is the $120,000 fair market value of the services. Perhaps, she should charge more. The difference is not considered a gift.
The CSU partnership distributed to each partner cash of $4,000, inventory with a basis of $4,000 and a fair market value (FMV) of $6,000, and land with an adjusted basis of $5,000 and an FMV of $3,000 in a liquidating distribution. Partner Chang had an outside basis in Chang’s partnership interest of $12,000. In the second year after receiving the liquidating distribution, Chang sold the inventory for $5,000 and the land for $3,000. What income must Chang report upon the sale of these assets?
a.
$0 gain or loss.
b.
$0 ordinary gain and $1,000 capital loss.
c.
$1,000 ordinary gain and $1,000 capital loss.
d.
$1,000 ordinary gain and $0 capital loss.
Choice “c” is correct. In this liquidating distribution of a partnership, three different assets are distributed. The $4,000 cash distributed reduces Chang’s (outside) basis in the partnership to $8,000. At that point, Chang’s outside basis is less than the total (inside) basis of the remaining property distributed. The inventory gets $4,000 of basis first and Chang’s outside basis is reduced to $4,000. The land gets the remaining $4,000 basis (whatever is left over). The sale of the inventory for $5,000 then produces a $1,000 ordinary gain ($5,000 - $4,000), and the sale of the land for $3,000 produces a $1,000 capital loss ($3,000 - $4,000).
Choice “a” is incorrect. There is gain or loss on the sale transactions because each of the assets distributed is sold for an amount that is different from its basis. This choice would require that the inventory be given a basis of $5,000 and the land be given a basis of $3,000.
Choice “b” is incorrect. A $0 ordinary gain could be recognized if the inventory were given a basis of $5,000, but there is no reason for doing that. The $1,000 capital loss is correct, but the choice is already incorrect.
Choice “d” is incorrect. A $0 capital loss could be recognized if the land were given a basis of $3,000. That would require that the land be given a basis of its fair market value on the distribution date. However, it is the bases of the property distributed that are allocated, not the fair market values. The $1,000 ordinary gain is correct, but the choice is already incorrect.
The individual partner rather than the partnership makes which of the following elections?
a.
Nonrecognition treatment for involuntary conversion gains.
b.
Code Section 179 deductions for tangible personal property.
c.
Election to amortize organizational costs.
d.
Whether to take a deduction or credit for taxes paid to foreign countries.
Choice “d” is correct. Most elections that affect the calculation of taxable income of a partnership are made by the partnership itself rather than by an individual partner. For example, the elections as to methods of accounting, methods of depreciation and the Section 179 expensing of a limited amount of depreciable property, the election not to use installment method accounting, and similar elections are made by the partnership and apply to all partners. However, individual partners can make the election to take a deduction or a credit for taxes paid to foreign countries.
Choice “c” is incorrect. The election to amortize organizational costs is made at the partnership level, not at the partner level.
Choice “a” is incorrect. The election not to recognize involuntary conversion gains is made at the partnership level, not at the partner level.
Choice “b” is incorrect. The election to expense Section 179 property is made at the partnership level, not at the partner level.
Molloy contributed $40,000 in cash in exchange for a one-third interest in the RST Partnership. In the first year of partnership operations, RST had taxable income of $60,000. In addition, Molloy received a $5,000 distribution of cash and, at the end of the partnership year, Molloy had a one-third share in the $18,000 of partnership recourse liabilities. What was Molloy’s basis in RST at year-end?
a.
$61,000
b.
$55,000
c.
$101,000
d.
$71,000
Choice “a” is correct. Molloy’s (adjusted) basis in the RST partnership includes its original cost ($40,000) plus its share of the partnership’s taxable income ($60,000 x 1/3 = $20,000). The basis is reduced by cash distributions ($5,000) and increased by its share of the partnership’s recourse liabilities (1/3 x $18,000 = $6,000). The total is $61,000.
Choice “b” is incorrect. The $55,000 is the $61,000 ignoring Molloy’s share of the partnership’s liabilities. However, the partnership’s recourse liabilities cannot be ignored.
Choice “d” is incorrect. The $71,000 is the $61,000 with the $5,000 cash distribution increasing, as opposed to reducing, the basis. However, the distribution reduces the basis.
Choice “c” is incorrect. The $101,000 is the $61,000 with the full amount ($60,000), instead of Molloy’s share ($20,000), of the partnership’s taxable income added. However, only Molloy’s share should be added to the basis.
Fern received $30,000 in cash and an automobile with an adjusted basis and market value of $20,000 in a proportionate liquidating distribution from EF Partnership. Fern’s basis in the partnership interest was $60,000 before the distribution. What is Fern’s basis in the automobile received in the liquidation?
a.
$30,000
b.
$0
c.
$10,000
d.
$20,000
Choice “a” is correct. In a complete liquidation of a partnership, the amount of cash distributed initially reduces the basis of the partner in the partnership (outside basis). In this question, the partner’s $60,000 basis in the partnership is reduced to $30,000 by the $30,000 cash distribution. The $30,000 remaining partner basis in the partnership is given to the other property distributed (in this question, the only property distributed was the automobile).
Choice “b” is incorrect. The $0 indicates that the automobile was given no basis. That would happen only if the cash distributed exceeded the partner’s basis in the partnership before the liquidation and distribution.
Choice “c” is incorrect. The $10,000 is the difference between the amount received in cash and the (fair) market value and basis of the automobile to the partnership. That amount does not represent the basis of the automobile after the distribution.
Choice “d” is incorrect. The $20,000 is the (fair) market value of the automobile at the date of the liquidation and distribution. That basis does not necessarily carry over to the partner.
A $100,000 increase in partnership liabilities is treated in which of the following ways?
a.
Increases each partner’s basis in proportion to their ownership.
b.
Does not change any partner’s basis in the partnership regardless of whether the liabilities are recourse or nonrecourse.
c.
Increases the partners’ bases only if the liability is nonrecourse.
d.
Increases each partner’s basis in the partnership by $100,000.
Rule: The partner’s original basis is increased by the portion of the liabilities assumed by the partner, and this amount is equal to the partner’s percentage ownership in the partnership.
Choice “a” is correct. A $100,000 increase in partnership liabilities generally increases each partner’s basis in proportion to their ownership percentage. [Thus, a 25% partner will generally have a basis increase of $25,000 for an increase in partnership debt of $100,000.]
Choice “d” is incorrect. This incorrectly says that each partner will have a basis increase of $100,000 for a total partnership debt increase of $100,000. A partner is only responsible for debt in the proportion of his/her ownership interest.
Choice “c” is incorrect. Partnership basis will increase in proportion to the partner’s economic loss percentage (risk) if the debt is recourse. Partnership basis may increase if the debt in nonrecourse, but there are limitations (beyond the scope of the exam).
Choice “b” is incorrect. A $100,000 increase in partnership liabilities generally increases each partner’s basis in proportion to their ownership percentage. Partnership basis will increase in proportion to the partner’s economic loss percentage (risk) if the debt is recourse. Partnership basis may increase if the debt in nonrecourse, but there are limitations (beyond the scope of the exam).
The adjusted basis of Smith’s interest in EVA partnership was $230,000 immediately before receiving the following distribution in complete liquidation of EVA:
Basis To EVA FMV
Cash $ 150,000 $ 150,000
Real estate 120,000 146,000
What is Smith’s basis in the real estate?
a.
$120,000
b.
$146,000
c.
$133,000
d.
$80,000
Rule: In a complete liquidation of a partnership, the partner’s basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received. The partner recognizes gain only to the extent that money received exceeds the partner’s basis in the partnership.
Choice “d” is correct. Smith’s basis in the real estate is calculated as follows:
Smith’s basis in EVA before liquidation $ 230,000
Cash received (150,000)
Smith’s basis in the real estate $ 80,000
Choice “b” is incorrect. This answer option incorrectly uses the fair market value of the land ($146,000) at the date of distribution in complete liquidation. In a complete liquidation of a partnership, the partner’s basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received.
Choice “c” is incorrect. This answer option incorrectly uses the average of the basis and the fair markets value of the real estate at the date of distribution [($120,000 + $146,000)/2 = $133,000]. In a complete liquidation of a partnership, the partner’s basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received.
Choice “a” is incorrect. This answer option incorrectly uses EVA’s basis of the land ($120,000) at the date of distribution in complete liquidation. In a complete liquidation of a partnership, the partner’s basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received.
Dale was a 50% partner in D&P Partnership. Dale contributed $10,000 in cash upon the formation of the partnership. D&P borrowed $10,000 to purchase equipment. During the first year of operations, D&P had $15,000 net taxable income, $2,000 tax-exempt interest income, a $3,000 distribution to each partner, and a $4,000 reduction of debt. At the end of the first year of operation, what amount would be Dale’s basis?
a.
$21,500
b.
$18,500
c.
$17,500
d.
$16,500
Rule: The partnership basis formula follows:
Basis = Capital Account + Partner’s Share of Liabilities
Choice “b” is correct. Dale’s basis at the end of the first year of operations is calculated as follows:
Initial contribution at formation $ 10,000
Net taxable income 7,500 [$15,000 × 50%]
Tax exempt income 1,000 [$2,000 × 50%]
Distributions (3,000) [to each partner]
Increase in debt responsible for 5,000 [$10,000 × 50%]
Reduction in debt responsible for (2,000) [$4,000 × 50%]
Basis at year end $ 18,500
Choice “d” is incorrect. There are a few ways to have miscalculated the basis by $2,000. The proper calculation of the basis at year end is shown above.
Choice “c” is incorrect. The most likely error made if this answer option were chosen is that the tax exempt income of $1,000 was omitted from being an increase in the partner’s basis in the partnership. All income (including tax free income) increases a partner’s basis.
Choice “a” is incorrect. The most likely error made if this answer option were chosen is that the distributions of $3,000 were omitted from being a decrease in the partner’s basis in the partnership; although, several other miscalculations could have been made. The proper calculation of the basis at year end is shown above.
On June 1, Year 1, Don Kerr received a 10% interest in the capital of Rev Company, a partnership, for services rendered. Rev’s net assets on June 1, Year 1, had a basis of $35,000 and a fair market value of $50,000. What income must Kerr include in his Year 1 tax return for the partnership interest transferred to him by the other partners?
a.
$5,000 ordinary income.
b.
$3,500 capital gain.
c.
$3,500 ordinary income.
d.
$5,000 capital gain.
Choice “a” is correct. $5,000 ordinary income.
Rule: If a person receives an interest in the capital of a partnership as a result of prior employment service, the fair market value of the interest acquired represents ordinary income to the recipient and is his basis in the partnership interest acquired.
The partnership’s net assets had a FMV of $50,000 as of June 1. Therefore, the FMV of the partnerships respective capital accounts was $50,000.
Total FMV of partnership capital accounts $ 50,000
Percentage received by Don Kerr 10%
Ordinary income to be reported $ 5,000
The following information pertains to Carr’s admission to the Smith & Jones partnership on July 1, Year 8:
Carr’s contribution of capital: 800 shares of Ed Corp. stock bought in 1975 for $30,000; fair market value $150,000 on July 1, Year 8.
Carr’s interest in capital and profits of Smith & Jones: 25%.
Fair market value of net assets of Smith & Jones on July 1, Year 8 after Carr’s admission: $600,000.
Carr’s gain in Year 8 on the exchange of the Ed stock for Carr’s partnership interest was:
a.
$0
b.
$120,000 long-term capital gain.
c.
$120,000 ordinary income.
d.
$120,000 Section 1231 gain.
Choice “a” is correct. $0.
Rule: There is no gain or loss recognized when a partner contributes property to a partnership in exchange for a partnership interest. Instead, the basis of the property contributed carries over and becomes the partnership’s basis in the property. Likewise, the basis of the property contributed net of any related loans assumed by the other partners, becomes the new partner’s basis in his partnership interest.
FMV of partner’s interest received (25% × 600,000) $150,000
Basis in property surrendered (stock acquired in Year 2) 30,000
Long term capital gain realized $120,000
Long term capital gain recognized $0
When the stock is later sold by the partnership, any gain recognition to the extent of the above unrecognized gain would be specifically allocated to the partner who contributed the property to the partnership.
Partnership Abel, Benz, Clark & Day is in the real estate and insurance business. Abel owns a 40% interest in the capital and profits of the partnership, while Benz, Clark, and Day each owns a 20% interest. All use a calendar year. At November 1 of the current year, the real estate and insurance business is separated, and two partnerships are formed: Partnership Abel & Benz takes over the real estate business, and Partnership Clark & Day takes over the insurance business. Which one of the following statements is correct for tax purposes?
a.
Informing Partnership Clark & Day, partners Clark and Day are subject to a penalty surtax if they contribute their entire distributions from Partnership Abel, Benz, Clark & Day.
b.
Before separating the two businesses into two distinct entities, Partnership Abel, Benz, Clark & Day must file a formal dissolution with the IRS on the prescribed form.
c.
Before separating the two businesses into two distinct entities, the partners must obtain approval from the IRS.
d.
Partnership Abel & Benz is considered to be a continuation of Partnership Abel, Benz, Clark & Day.
Choice “d” is correct. Partnership Abel & Benz is considered to be a continuation of partnership Abel, Benz, Clark, and Day as Abel (40%) and Benz (20%) constitute more than 50% of the old partnership.
Choice “a” is incorrect. No such penalty surtax exists. Normally, there would be no tax consequence resulting from a distribution from the original partnership unless the amount of cash distributed to the partners exceeded their respective basis in their partnership interest.
Choice “c” is incorrect. Separating the two businesses into two entities does not require approval from the IRS.
Choice “b” is incorrect. A partnership does not terminate and therefore does not require a formal dissolution with the IRS unless:
It stops doing business.
50% or more of the total interest in the partnership capital and profits changes hands by sale of exchange within 12 consecutive months.
Only one partner remains which makes it a sole proprietorship.
Dale’s distributive share of income from the calendar- year partnership of Dale & Eck was $50,000 in Year 1. On December 15, Year 1, Dale, who is a cash-basis taxpayer, received a $27,000 distribution of the partnership’s Year 1 income, with the $23,000 balance paid to Dale in May Year 2. In addition, Dale received a $10,000 interest-free loan from the partnership in Year 1. This $10,000 is to be offset against Dale’s share of Year 2 partnership income. What total amount of partnership income is taxable to Dale in Year 1?
a.
$27,000
b.
$37,000
c.
$60,000
d.
$50,000
Choice “d” is correct. The total amount of partnership income taxable to Dale in Year 1 is $50,000, which is his distributive share of partnership income.
Rule: A partner must include his allocated share of partnership income, even if not received in cash, in his tax return for his taxable year (usually calendar year) within which the taxable year of the partnership ends.
Choices “a”, “b”, and “c” are incorrect, per the above rule.
Which one of the following statements regarding a partnership’s tax year is correct?
a.
A “valid business purpose” can no longer be claimed as a reason for adoption of a tax year other than the generally required tax year.
b.
A partnership formed on July 1 is required to adopt a tax year ending on June 30.
c.
A partnership may elect to have a tax year other than the generally required tax year if the deferral period for the tax year elected does not exceed three months.
d.
Within 30 days after a partnership has established a tax year, a form must be filed with the IRS as notification of the tax year adopted.
Choice “c” is correct. A partnership may elect to have a tax year other than the generally required tax year if the deferral period for the tax year elected does not exceed three months.
Choice “b” is incorrect. Generally, partnerships must adopt the same taxable year as the majority of their partners (usually December 31) unless a natural business year exception or the above exception applies.
Choice “a” is incorrect. A valid business purpose reason for adoption of a tax year other than the generally required tax year may still apply if approved by IRS.
Choice “d” is incorrect. No such form or filing requirement exists.
Hart’s adjusted basis of his interest in a partnership was $30,000. He received a nonliquidating distribution of $24,000 cash plus a parcel of land with a fair market value and partnership basis of $9,000. Hart’s basis for the land is:
a.
$9,000
b.
$3,000
c.
$0
d.
$6,000
Choice “d” is correct. Hart’s basis for the land is $6,000.
Rule: The basis of property received in a distribution, other than in liquidation of a partner’s interest, will ordinarily be the same as the basis in the hands of the partnership immediately prior to distribution. However, in no case may the basis of property in the hands of the partner exceed the basis of his partnership interest reduced by the amount of money distributed to him in the same transaction.
Partnership interest adjusted prior to distribution $ 30,000
Amount of cash distributed (24,000)
Remaining basis after cash distribution 6,000
Distribution of land with basis of $9,000 (6,000)
Remaining partnership interest $ 0
The partnership interest may not be reduced below zero. Therefore, the land has a basis of $6,000 in the hands of the partner.
Eng contributed the following assets to a partnership in exchange for a 50% interest in the partnership’s capital and profits:
Cash $50,000
Equipment:
Fair market value 35,000
Carrying amount (adjusted basis) 25,000
The basis for Eng’s interest in the partnership is:
a.
$42,500
b.
$37,500
c.
$85,000
d.
$75,000
Choice “d” is correct. The basis for Eng’s interest in the partnership is $75,000 computed as follows:
Cash $ 50,000
Adjusted basis of eqpt. 25,000
Total partnership interest basis $ 75,000
Rule: In general, a partner’s basis in his/her partnership interest will be the amount of cash contributed plus the adjusted basis of any property contributed in exchange for the interest.
Choices “b”, “a”, and “c” are incorrect, per the above rule.
Under the Internal Revenue Code sections pertaining to partnerships, guaranteed payments are payments to partners for:
a.
Services or the use of capital without regard to partnership income.
b.
Sales of partners’ assets to the partnership at guaranteed amounts regardless of market values.
c.
Payments of principal on secured notes honored at maturity.
d.
Timely payments of periodic interest on bona fide loans that are not treated as partners’ capital.
Choice “a” is correct. Under the Internal Revenue Code, guaranteed payments are payments to partners for services rendered or the use of capital without regard to partnership income.
Choices “c”, “d”, and “b” are incorrect, per the above definition of a guaranteed payment.
The basis to a partner of property distributed “in kind” in complete liquidation of the partner’s interest is the:
a.
Adjusted basis of the partner’s interest increased by any cash distributed to the partner in the same transaction.
b.
Adjusted basis of the partner’s interest reduced by any cash distributed to the partner in the same transaction.
c.
Adjusted basis of the property to the partnership.
d.
Fair market value of the property.
Choice “b” is correct. Adjusted basis of the partner’s interest reduced by any cash distributed to the partner in the same transaction.
Rule: Upon dissolution, the “basis” of property distributed to a partner will be the partner’s “adjusted basis” in the partnership, net of any cash distributions (not FMV of property distributed).
Choice “a” is incorrect. In a liquidation, the basis of property received is reduced to the extent of cash received in the liquidating distribution.
Choice “c” is incorrect. The basis of property distributed in a complete liquidation is the adjusted basis of the property to the partnership net of any cash distributed.
Choice “d” is incorrect, per the above rule.
Which of the following limitations will apply in determining a partner’s deduction for that partner’s share of partnership losses?
~~At-risk
~~Passive loss
a.
Yes
No
b.
Yes
Yes
c.
No
Yes
d.
No
No
Choice “b” is correct. Both the “at-risk” limits and the “passive loss” limits will apply in determining a partner’s deduction for that partner’s share of partnership losses. Partners are subject to the basis limitations on losses, the “at-risk” provisions and the passive loss limitations on the losses passed through from the partnership.
Choices “a”, “c”, and “d” are incorrect, per the above.
Which of the following should be used in computing the basis of a partner’s interest acquired from another partner?
~~Cash paid by transferee to transferor
~~Transferee’s share of partnership liabilities
a.
Yes
No
b.
No
Yes
c.
No
No
d.
Yes
Yes
Choice “d” is correct.
Rule: A partner’s basis for his partnership interest consists of the amount of cash paid for the interest, plus the adjusted basis of property transferred for the interest, plus the new partner’s share of partnership liabilities.
Choices “b”, “a”, and “c” are incorrect, per the above rule.
The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date:
a.
The partner’s holding period of the capital asset began.
b.
The partner is first credited with the proportionate share of partnership capital.
c.
The partner transfers the asset to the partnership.
d.
The partner is admitted to the partnership.
Choice “a” is correct.
Rule: The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date the partner’s holding period of the capital asset began.
Choices “d”, “c”, and “b” are incorrect, per the above rule.
On January 1 of the current year, Kane was a 25% equal partner in Maze general partnership, which had partnership liabilities of $300,000. On January 2, a new partner was admitted and Kane’s interest was reduced to 20%. On April 1, Maze repaid a $100,000 general partnership loan. Ignoring any income, loss, or distributions for the current year, what was the net effect of the two transactions on Kane’s tax basis in Maze partnership interest?
a.
Decrease of $75,000.
b.
Decrease of $35,000.
c.
Increase of $15,000.
d.
Has no effect.
Choice “b” is correct. There would be a $35,000 decrease of Kane’s tax basis in his capitalize partnership interest.
Rule: Basis in a partnership is increased by debt that a partner is personally liable for and decreased by the amount of liabilities a partner is relieved of.
Kane’s 25% of debt ($300,000 times 25%) $ 75,000
Kane’s 20% of debt ($300,000 times 20%) (60,000)
Reduction of basis due to admission of new partner 15,000
Add: Reduction of basis for the $100,000 general partnership liability ($100,000 times 20%) 20,000
Total reduction $ 35,000
Choices “d”, “c”, and “a” are incorrect, per the above rule and calculation.
Under which of the following circumstances is a partnership that is not an electing large partnership considered terminated for income tax purposes?
I.
Fifty-five percent of the total interest in partnership capital and profits is sold within a 12-month period.
II.
The partnership’s business and financial operations are discontinued.
a.
II only.
b.
Both I and II.
c.
I only.
d.
Neither I nor II.
Choice “b” is correct. Such a partnership will be terminated for income tax purposes when either fifty percent or more of the total interest in capital and profits is sold within a 12-month period or the partnership’s business and financial operations are discontinued.
Basic Partnership, a cash-basis calendar year entity, began business on February 1, Year 1. Basic incurred and paid the following in Year 1:
Filing fees incident to the creation of the partnership $ 3,600
Accounting fees to prepare the representations in offering materials 12,000
Basic elected to amortize costs. What was the maximum amount that Basic could deduct on the Year 1 partnership return?
a.
$2,860
b.
$3,600
c.
$11,000
d.
$220
Choice “b” is correct. Only the filing fees incident to the creation of the partnership are eligible expenditures. Generally speaking, expenditures up to $5,000 can be immediately deducted. Remaining expenses are amortized over 180 months.
On June 1, Year 1, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock’s net assets at that date had an adjusted basis of $70,000 and a fair market value of $100,000. In Kelly’s Year 1 income tax return, what amount must Kelly include as income from transfer of partnership interest?
a.
$10,000 ordinary income.
b.
$10,000 capital gain.
c.
$7,000 capital gain.
d.
$7,000 ordinary income.
Choice “a” is correct. Kelly must include as ordinary income the fair market value of the asset received, a 10% interest in a partnership valued at $100,000, or $10,000. It is ordinary income since Kelly provided services for the partnership interest.
Choice “d” is incorrect. Use Kelly’s share of the fair market value of the partnership, not its adjusted basis.
Choice “c” is incorrect. Use Kelly’s share of the fair market value of the partnership, not its adjusted basis. Also, Kelly must include this value as ordinary income since Kelly provided services for the partnership interest.
Choice “b” is incorrect. The $10,000 is ordinary income because Kelly provided services for the partnership interest.
Strom acquired a 25 percent interest in Ace Partnership by contributing land having an adjusted basis of $16,000 and a fair market value of $50,000. The land was subject to a $24,000 mortgage, which was assumed by Ace. No other liabilities existed at the time of the contribution. What was Strom’s basis in Ace?
a.
$26,000
b.
$32,000
c.
$16,000
d.
$0
Choice “d” is correct. Strom’s basis in the land ($16,000) carries over as an element of his basis in Ace. The assumption by Ace of Strom’s liabilities on the land ($24,000) is treated as a distribution of money to Strom, which reduces his basis temporarily to negative $8,000. Then, through his status as a partner of Ace, Strom is treated as re-assuming 25% of the liability, or $6,000, and this increases his basis temporarily to negative $2,000. Since it is impossible to have negative basis, Strom realizes a gain (usually capital) of $2,000, the amount necessary to bring his basis up to zero.
Choice “c” is incorrect. Strom’s basis in Ace is reduced because of the liability assumed by Ace.
Choice “a” is incorrect. Strom’s basis in the land ($16,000) carries over as an element of Strom’s basis in Ace.
Choice “b” is incorrect. Strom’s basis in the land ($16,000) carries over as an element of Strom’s basis in Ace. Then, Strom’s basis in Ace is reduced because of the liability assumed by Ace.
Dean is a 25% partner in Target Partnership. Dean’s tax basis in Target on January 1, 20X1, was $20,000. At the end of 20X1, Dean received a nonliquidating cash distribution of $8,000 from Target. Target’s 20X1 accounts recorded the following items:
Municipal bond interest income $ 12,000
Ordinary income 40,000
What was Dean’s tax basis in Target on December 31, 20X1?
a.
$15,000
b.
$30,000
c.
$23,000
d.
$25,000
Choice “d” is correct. Dean’s basis in Target is calculated by starting with his basis at January 1, 20X1 ($20,000) and adding his 25% share of partnership income items for the year. The nontaxable municipal bond income increases his basis as does the ordinary income. Target’s income items include the municipal bond income ($12,000) plus the ordinary income ($40,000) for a total of $52,000, of which Dean’s 25% share is $13,000. This is added to the beginning basis of $20,000, and the $8,000 cash distribution is deducted leaving a balance at December 31, 20X1, of $25,000.
Choice “a” is incorrect. This answer fails to take into account Dean’s distributive share of the ordinary income of Target.
Choice “c” is incorrect. This answer appears to be a distracter.
Choice “b” is incorrect. This answer fails to take into consideration the effect on Dean’s basis of both the nonliquidating cash distribution and Dean’s distributive share of Target’s municipal bond interest income.
Peters has a one-third interest in the Spano Partnership. During 20X1, Peters received a $16,000 guaranteed payment, which was deductible by the partnership, for services rendered to Spano. Spano reported a 20X1 operating loss of $70,000 before the guaranteed payment. What is(are) the net effect(s) of the guaranteed payment?
I.
The guaranteed payment increases Peters’ tax basis in Spano by $16,000.
II.
The guaranteed payment increases Peters’ ordinary income by $16,000.
a.
Both I and II.
b.
I only.
c.
II only.
d.
Neither I nor II.
Choice “c” is correct. The guaranteed payment increases Peters’ ordinary income by $16,000 but does not affect Peters’ tax basis because guaranteed payments are not undistributed earnings (they are distributed to the partner). The answer is “II only.”
Rule: Guaranteed payments are reasonable compensation paid to a partner for services rendered without regard to the partner’s ratio of income. They are allowable tax deductions to the partnership and ordinary income to the partner receiving them.
Note: A guaranteed payment will not increase a partner’s basis in the partnership because the payment has been distributed to the partner.
Choices “b”, “a”, and “d” are incorrect, per the above rule and note.
Evan, a 25% partner in Vista Partnership, received a $20,000 guaranteed payment in 20X1 for deductible services rendered to the partnership. Guaranteed payments were not made to any other partner. Vista’s 20X1 partnership income consisted of:
Net business income before guaranteed payments $ 80,000
Net long-term capital gains 10,000
What amount of income should Evan report from Vista Partnership on his 20X1 tax return?
a.
$20,000
b.
$37,500
c.
$22,500
d.
$27,500
Choice “b” is correct. Evan’s income from Vista is $37,500, calculated as follows:
Partnership income before guaranteed payment to Evan $ 80,000
Deductible guaranteed payment to Evan (20,000)
Net taxable partnership income 60,000
Evan’s share of partnership income 25%
Evan’s amount of partnership income 15,000
Evan’s 25% share of Vista’s $10,000 capital gain 2,500
Evan’s guaranteed payment from Vista 20,000
20X1 Vista income reportable on Evan’s return $ 37,500
Choice “d” is incorrect. Evan needs to calculate the percentage of partnership income allocable to his share of the partnership. In addition Evan needs to include the guaranteed payment.
Choices “c” and “a” are incorrect. Evan needs to report more than the guaranteed payment and share of capital gain on his tax return. Evan needs to calculate the percentage of partnership income allocable to his share of the partnership.
The adjusted basis of Jody’s partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and property with an adjusted basis to the partnership of $40,000 and a fair market value of $35,000.
What amount of taxable gain must Jody report as a result of this distribution?
a.
$5,000
b.
$10,000
c.
$0
d.
$20,000
Choice “c” is correct. The $20,000 current distribution of cash is first applied to Jody’s $50,000 basis, reducing it to $30,000. The current distribution of property is then applied at its $40,000 basis. Since Jody’s remaining basis is $30,000, only $30,000 is applied to the property distribution, resulting in $0 taxable gain to Jody and $0 remaining basis in the partnership.
Choice “a” is incorrect. First, the cash distribution is fully applied, then the property distribution is applied at adjusted basis until the partner’s basis is zero. No gain is generally recognized by the partner as a result of a current distribution unless the cash distributed is in excess of the partner’s basis. In that case, the excess would be a gain to the partner (to avoid a negative basis).
Choice “b” is incorrect. The $10,000 gain is not recognized since the property distributed takes on a $30,000 basis to the partner.
Choice “d” is incorrect. First, the cash distribution is fully applied, then the property distribution is applied at adjusted basis until the partner’s basis is zero. No gain is generally recognized by the partner as a result of a current distribution unless the cash distributed is in excess of the partner’s basis. In that case, the excess would be a gain to the partner (to avoid a negative basis).
The adjusted basis of Jody’s partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and property with an adjusted basis to the partnership of $40,000 and a fair market value of $35,000.
What is Jody’s basis in the distributed property?
a.
$35,000
b.
$0
c.
$30,000
d.
$40,000
Choice “c” is correct. Jody’s basis in the distributed property is $30,000, Jody’s remaining basis in the partnership after the cash distribution:
Jody’s partnership basis
$ 50,000
Cash distribution and Jody’s basis in cash
(20,000)
$ 30,000
Property distribution and Jody’s basis in the property
(30,000)
*
Jody’s partnership basis after distributions
$ 0
* If the partner’s basis in the partnership ($30,000) is less than the property’s basis ($40,000), the partner’s basis in the property is limited to her basis in the partnership ($30,000).
Choice “b” is incorrect. $0 is Jody’s basis in the partnership after the distributions, not her basis in the property.
Choice “a” is incorrect. The partner’s basis in distributed property is equal to the partnership’s basis in the distributed property, not the fair market value. In this instance, because the partnership’s basis exceeds the partner’s basis in the partnership, the partner’s basis is limited.
Choice “d” is incorrect. If the partner’s basis in the partnership is less than the property’s basis, the partner’s basis in the property is limited to her basis in the partnership. Remember, the cash distributed must be subtracted from the partner’s basis first.
The adjusted basis of Vance’s partnership interest in Lex Associates was $180,000 immediately before receiving the following distribution in complete liquidation of Lex:
Basis to Lex Fair market value
Cash $100,000 $100,000
Real estate 70,000 96,000
What is Vance’s basis in the real estate?
a.
$80,000
b.
$83,000
c.
$96,000
d.
$70,000
Choice “a” is correct. In a liquidating distribution, the $100,000 cash is applied first to the $180,000 partnership basis, reducing it to $80,000. Even though the partnership’s basis in the real estate is only $70,000, Vance’s basis in the real estate will be his partnership basis ($80,000) since this is the last asset distributed and it is a liquidating distribution (i.e., Vance’s partnership basis must be reduced to zero). Neither Vance nor the partnership recognizes any gain or loss from the distribution.
Choice “c” is incorrect. The real estate’s fair market value is not used.
Choice “b” is incorrect. $83,000 is the average of the $70,000 basis and the $96,000 fair market value. The average of the two amounts is not used.
Choice “d” is incorrect. Even though the partnership’s basis in the real estate is $70,000, Vance’s basis in the real estate will be stepped up to $80,000, Vance’s remaining basis in the partnership. Because this is a liquidating distribution, Vance’s basis in the partnership must be reduced to zero.
On December 31 of the current year, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all liabilities. On that date, the adjusted basis of Clark’s partnership interest was $40,000, consisting of his capital account of $15,000 and his share of the partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark’s gain or loss on the sale of his partnership interest?
a.
Capital gain of $15,000.
b.
Ordinary gain of $15,000.
c.
Ordinary loss of $10,000.
d.
Capital loss of $10,000.
Choice “a” is correct. When a partner sells his partnership interest, capital gain or loss on the sale is recognized. To the extent that there are Sec. 751(a) hot assets (unrealized receivables or substantially appreciated inventory), the partner must recognize ordinary income or loss. In this case, the partnership has no Sec. 751 assets. The amount realized less the partner’s basis in the partnership is the capital gain or loss. The amount realized is $55,000 ($30,000 cash received + $25,000 relief of debt). The partner’s basis in the partnership is $40,000. Thus, the capital gain is $55,000 − $40,000, or $15,000.
Choice “c” is incorrect. Since there are no Sec. 751 assets, the gain or loss must be capital, not ordinary.
Choice “b” is incorrect. Since there are no Sec. 751 assets, the gain or loss must be capital, not ordinary.
Choice “d” is incorrect. The amount realized must include the $25,000 debt relief.
Which of the following is both an item that is an allowable tax deduction to the partnership and is reported separately on the individual partner’s Schedule K-1?
a.
Advertising expenditures.
b.
Depreciation on equipment used in the business.
c.
Guaranteed payments paid to partners.
d.
Salaries paid to non-partner employees.
Choice “c” is correct. A partnership calculates net business income or loss and passes each partner’s distributive share through on the Schedule K-1. Guaranteed payments paid to partners for services rendered or for the use of capital, without regard to partnership income or profit and loss sharing ratios, are an allowable tax deduction to the partnership and are separately reported on Schedule K-1 for inclusion on the partner’s tax return.
Choice “d” is incorrect. Salaries paid to non-partner employees are deducted from revenues to arrive at net business income or loss at the partnership level. Each partner’s distributive share of the net income or loss is then reported on the Schedule K-1.
Choice “a” is incorrect. Advertising expenditures incurred by the partnership are deducted from revenues to arrive at net business income or loss at the partnership level. Each partner’s distributive share of the net income or loss is then reported on the Schedule K-1.
Choice “b” is incorrect. Depreciation of assets used in the business is deducted from revenues to arrive at net business income or loss at the partnership level. Each partner’s distributive share of the net income or loss is then reported on the Schedule K-1.
In the absence of an election to adopt an annual accounting period, the required tax year for a partnership is:
a.
A tax year that results in the greatest aggregate deferral of income.
b.
A tax year of a principal partner having a 10% or greater interest.
c.
A calendar year.
d.
A tax year of one or more partners with a more than 50% interest in profits and capital.
Rule: Per IRC Section 706(b), a partnership tax year must have the same taxable year as the common taxable year of the partners that, in the aggregate, have interest greater than 50%, which is determined based on the “testing day,” the first day of the partnership’s tax year (not considering the majority interest rule). Note: After a change is made to the “majority-interest” tax year end, the partnership does not have to change to another tax year for two years following the year of change. Exceptions to the rule exist. (1) If there is no “majority-interest” tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the partnership). (2) If the partnership is still unable to determine a tax year using the general rule or the first exception, then the tax year that causes the least aggregate deferral of income to the partners must be adopted.
Choice “d” is correct. In the absence of election to adopt an annual accounting period, the required tax year for a partnership is the tax year of one or more partners who, in aggregate, have more than 50% interest in profits and capital, per the majority interest rule.
Choice “a” is incorrect. If there is no “majority-interest” tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the partnership). If the partnership is still unable to determine a tax year using the general rule or the first exception, then the tax year that causes the least aggregate deferral of income to the partners must be adopted.
Choice “c” is incorrect. A partnership may be able to avoid the rules above if it has a business purpose for selecting a different tax year and if this can be established with the IRS. In this case, a calendar year (assuming it is not already required because it coincides with the general rule or the exceptions identified above) may be used.
Choice “b” is incorrect. If there is no “majority-interest” tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the partnership).
Brown, a 50% partner in Brown & White, received a distribution of $12,500 in the current year. The partnership’s income for the year was $25,000. What is the character of the payment that Brown received?
a.
Partial liquidation.
b.
Liquidating distribution.
c.
Current distribution.
d.
Disproportionate distribution.
Rule: IRC Section 731 controls the taxability of partnership distributions. A partner who receives a distribution from a partnership realizes gain only to the extent that he receives cash in excess of the adjusted basis of his interest in the partnership immediately before the distribution.
Choice “c” is correct. This distribution is a current distribution (a distribution other than in liquidation of an entire partnership interest). Brown is a 50% partner and he/she received ½ of the partnership’s income in cash.
Choice “a” is incorrect. There is nothing in the question that indicates that the distribution is a liquidating distribution, partial or not.
Choice “b” is incorrect. There is nothing in the question that indicates that the distribution is a liquidating distribution of any kind.
Choice “d” is incorrect. This distribution is not a disproportionate distribution since Brown is a 50% partner and he/she received ½ of the partnership’s income.
“Hot assets” of a partnership would include which of the following?
a.
Unrealized receivables.
b.
Cash.
c.
Section 1231 assets.
d.
Capital assets.
Explanation
Choice “a” is correct. As a general rule, a partner who sells or exchanges his or her partnership interest has a recognized capital gain or loss. The capital gain or loss is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest.
An exception to the capital gain treatment is on any gain that represents a partner’s share of “hot assets”. Any gain that represents a partner’s share of hot assets is treated as ordinary income. Hot assets are: (1) Unrealized receivables and, (2) Appreciated inventory.
Choice “b” is incorrect. Cash is not a hot asset.
Choice “c” is incorrect. Section 1231 assets are not hot assets.
Choice “d” is incorrect. Capital assets are not hot assets.
George and Martha are equal partners in G&M Partnership. At the beginning of the current tax year, the adjusted basis of George’s partnership interest was $32,500, which included his share of $40,000 of partnership liabilities. During the tax year, the following information applied to G&M:
Operating loss $ 30,000
Interest and dividend income 8,000
Partnership liabilities at end of year 24,000
What was the basis of George’s partnership interest at year end?
a.
$43,500
b.
$13,500
c.
$29,500
d.
$21,500
Choice “b” is correct. A partner’s share of operating losses reduces that partner’s basis. Likewise, a reduction in a partner’s share of liabilities reduces basis. A partner’s basis will increase by that partner’s share of income such as dividends and interest.
Initial basis in partnership interest $ 32,500
Equal share of interest and dividends 4,000
Equal share of operating loss (15,000)
Share of decreased partnership liabilities at year end (8,000)
Basis of George’s partnership interest at year end $ 13,500
Choice “d” is incorrect. Reducing liabilities decreases basis.
Choice “c” is incorrect. Equal partners would divide partnership activity equally.
Choice “a” is incorrect. Operating losses are a reduction of basis.
As a general partner in Greenland Associates, an individual’s share of partnership income for the current tax year is $25,000 ordinary business income and a $10,000 guaranteed payment. The individual also received $5,000 in cash distributions from the partnership. What income should the individual report from the interest in Greenland?
a.
$25,000
b.
$35,000
c.
$5,000
d.
$40,000
Choice “b” is correct. A partner must include in income their share of partnership income (even if not received) on their tax return in the taxable year within which the taxable year of the partnership ends. This income includes guaranteed payments.
Withdrawals/distributions are not a taxable event, yet will decrease the partner’s basis.
Choice “c” is incorrect. Cash distributions are not included in income.
Choice “a” is incorrect. Guaranteed payments are taxable income to the receiving partner.
Choice “d” is incorrect. Distributions are not income, since the money was taxed when the partnership earned such money, but would reduce the partner’s basis.
Campbell acquired a 10% interest in Vogue Partnership by contributing a building with an adjusted basis of $40,000 and a fair market value of $90,000. The building was subject to a $60,000 mortgage that was assumed by Vogue. The other partners contributed cash only. The basis of Campbell’s partnership interest in Vogue is:
a.
$30,000
b.
$0
c.
$34,000
d.
$84,000
Choice “b” is correct. A partner’s initial basis in their partnership interest is determined by, among other items, the adjusted basis of appreciated property contributed. Such basis is reduced by liabilities assumed by the other partners.
When property that is subject to a liability is contributed to a partnership and the subsequent decrease in the partner’s individual liability exceeds partnership basis, the excess amount is treated like taxable boot, which means there is a taxable gain to the partner.
Initial Basis: $40,000
(basis in asset contributed to the partnership)
Less: liabilities assumed by others: (54,000)
($60,000 in total liabilities less 10% retained)
Net Basis: ($14,000)
Excess liability, taxable to Campbell
Campbell’s basis in partnership: $0
Choice “d” is incorrect. Basis determination begins with the contributed asset’s basis, not fair market value.
Choice “c” is incorrect. The incoming partner is considered as being relieved of 90% of the liability because the partner is purchasing a 10% interest. Therefore, 90% of the liability is the responsibility of the other partners.
Choice “a” is incorrect. Basis determination begins with the contributed asset’s basis, not fair market value.
Ken Karas owns an 80% interest in the capital and profits of the partnership of Karas & Keel. On July 1 of the current year, Karas bought surplus land from the partnership at the land’s fair market value of $30,000. The partnership’s basis in the land was $36,000. For the current calendar year end, the partnership’s net income was $85,000, after recording the $6,000 loss on the sale of the land. Karas’ distributive share of ordinary income from the partnership for the current year was:
a.
$91,000
b.
$68,000
c.
$63,200
d.
$72,800
Choice “d” is correct. Losses between a controlling partner (over 50% interest in capital and profits) and his controlled partnership from the sale or exchange of property are not allowed. Thus the disallowance of the $6,000 loss would make the ordinary income $91,000 and 80% of that is $72,800.
Choice “c” is incorrect. This results if the loss is subtracted again from the partnership’s ordinary income [($85,000 - 6,000) x 80% = $63,200].
Choice “b” is incorrect. This answer did not disallow the loss but merely took 80% of the $85,000.
Choice “a” is incorrect. This answer is the total loss of the partnership. It must be multiplied by the partner’s ownership interest.
Choice “d” is correct. Losses between a controlling partner (over 50% interest in capital and profits) and his controlled partnership from the sale or exchange of property are not allowed. Thus the disallowance of the $6,000 loss would make the ordinary income $91,000 and 80% of that is $72,800.
Choice “c” is incorrect. This results if the loss is subtracted again from the partnership’s ordinary income [($85,000 - 6,000) x 80% = $63,200].
Choice “b” is incorrect. This answer did not disallow the loss but merely took 80% of the $85,000.
Choice “a” is incorrect. This answer is the total loss of the partnership. It must be multiplied by the partner’s ownership interest.
Kent King’s adjusted basis for his partnership interest in Troy Partnership was $32,000. In complete liquidation of his interest in Troy, King received cash of $2,000 and realty having a fair market value of $25,000. Troy’s adjusted basis for this realty was $15,000. King’s basis for the realty after distribution is:
a.
$13,000
b.
$25,000
c.
$15,000
d.
$30,000
Choice “d” is correct. In a liquidating distribution, a partner’s basis in the distributed property is the same as the adjusted basis of his partnership interest reduced for any monies actually received. King’s basis in his partnership interest was $32,000 less $2,000 cash received, leaving $30,000 of basis to be allocated to the realty received.
Choices “a”, “c”, and “b” are incorrect, per the above explanation.
Ball and Baig are equal partners in the firm of Games Associates. On January 1 of the current year, each partner’s adjusted basis in Games was $50,000. During the year, Games borrowed $80,000 for which Ball and Baig are personally liable. Games sustained an operating loss of $30,000 for the current year. The basis of each partner’s interest in Games at the end of the current year was:
a.
$50,000
b.
$35,000
c.
$65,000
d.
$75,000
Explanation
Choice “d” is correct. A partner’s basis in his partnership interest is the combination of his capital account and his share of liabilities that he is personally liable for. The beginning basis of $50,000 should be decreased by each partner’s share of the $30,000 operating loss, or $15,000, and increased for each partner’s share of the liabilities, or $40,000, for current calendar year end basis of $75,000.
Choices “b”, “a”, and “c” are incorrect, per the above explanation.
At the beginning of the tax year, Martin Crouch contributed property to a new partnership in return for a 25% interest in capital and profits. The property contributed had a fair market value of $150,000, an adjusted basis of $100,000, and was subject to a $100,000 mortgage, which was assumed by the partnership. What was Martin’s basis in the partnership as a result of the contribution?
a.
$25,000
b.
$0
c.
$150,000
d.
$100,000
Choice “a” is correct. Following the basis formula yields:
+ Cash $ 0
+ Adjusted basis of property 100,000
− Liabilities (amount assumed by other partners) 75,000
+ FMV of services rendered (if applicable) 0
+ Liabilities - other partner’s liabilities assumed by the incoming partner 0
= basis $ 25,000
Choices “b”, “d”, and “c” are incorrect, per the above calculation.
Mom and Pop Partnership had the following results during the taxable year:
Income from operations
$100,000
loss
Capital gain from sale of land
25,000
Charitable contributions
10,000
Junior, a 50% partner, had an adjusted basis of $40,000 at December 31, without regard to the current year income or loss items. In preparing his individual income tax return, Junior should report which of the following amounts?
~~Ordinary Loss
~~Capital Gain
~~Charitable Contributions
a.
$32,500
$0
$0
b.
$50,000
$12,500
$5,000
c.
$47,500
$12,500
$5,000
d.
$40,000
$12,500
$5,000
Choice “c” is correct. The deduction of the ordinary loss is limited to Junior’s basis and any at risk amounts. Junior’s basis is calculated as $40,000 + $12,500 capital gain - $5,000 charitable contributions = $47,500; thus the ordinary loss deducted on his return would be limited to $47,500.
Choices “b” and “d” are incorrect. Both of these options incorrectly state the ordinary loss. Choice “b” did not take into account the limitation to basis and choice “d” did not take into account the adjustment of basis by the other income/deduction items for the year.
Choice “a” is incorrect. The loss, capital gain, and charitable contributions are all stated separately - income from operations is passed through as a net number to the partners and charitable contributions and capital gain are separately stated items, not netted in that figure.
Turner, Reed, and Sumner are equal partners in TRS partnership. Turner contributed land with an adjusted basis of $20,000 and a fair market value (FMV) of $50,000. Reed contributed equipment with an adjusted basis of $40,000 and an FMV of $50,000. Sumner provided services worth $50,000. What amount of income is recognized as a result of the transfers?
a.
$150,000
b.
$90,000
c.
$50,000
d.
$60,000
Choice “c” is correct. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest (note: when contributed property is subject to a liability, if the decrease in the contributing partner’s individual basis exceeds the partner’s partnership basis, the excess amount is treated like taxable boot and is a gain to that partner). So, given the facts in this question, Turner and Reed will recognize no income or gain.
On the other hand, the value of a partnership acquired for services is ordinary income to the partner rendering those services. So, Summer must recognize $50,000 of ordinary income on account of Summer’s rendering to the partnership $50,000 worth of services in exchange for a partnership interest.
Choices “d”, “b”, and “a” are incorrect per the above rules.
While preparing a partnership tax return, the accountant discovered that ABC Partnership distributed property to Anne, a partner, in a nonliquidating transfer. No money was distributed to Anne during the year, the property was in the partnership for over five years, and no debt was attached to the property. Anne had a basis in her partnership interest of $10,000. The partnership had an adjusted basis of $20,000 in the property distributed to Anne. Which of the following are the tax consequences to Anne?
a.
$0 gain, basis in the partnership is reduced to $0, and basis in the property received is $20,000.
b.
$0 gain, basis in the partnership is reduced to $0, and basis in the property received is $10,000.
c.
$10,000 gain, basis in the partnership is reduced to $0, and basis in the property received is $20,000.
d.
$10,000 gain, basis in the partnership is unchanged, and basis in the property received is $20,000.
Choice “b” is correct. General rules:
A nonliquidating distribution to a partner is nontaxable.
In nonliquidating distribution to a partner, the basis of property received will be the same as the basis in the hands of the partnership immediately prior to the nonliquidating distribution.
Distributions to a partner reduce the partner’s basis by the cash the partner receives and by the partnership’s adjusted basis in property which the partner receives.
Exception to the general rule (the exception does not apply to the facts set forth in the question): Gain is recognized only to the extent that cash (including the partner’s share of partnership liabilities are assumed by other partners) distributed exceeds the adjusted basis of the partner’s interest in the partnership immediately before the distribution.
In this question, the partner received no cash, and the partner’s share of partnership liabilities did not change. So, the partner will recognize no gain with respect to the distribution. Although the partnership’s adjusted basis in the distributed property was $20,000, because the partner’s basis in the partner’s partnership interest was only $10,000, the adjusted basis of the property which the partner received will be limited to $10,000. The new basis in the partnership interest will be reduced from $10,000 to -0-.
Choices “a”, “c”, and “d” are incorrect per the above rules.
Able and Baker are equal members in Apple, an LLC. Apple has elected not to be treated as a corporation. Able contributes $7,000 cash and Baker contributes a machine with a basis of $5,000 and a fair market value of $10,000, subject to a liability of $3,000. What is Apple’s basis for the machine?
a.
$10,000
b.
$2,000
c.
$8,000
d.
$5,000
Choice “d” is correct. This LLC has elected not to be treated as a corporation. Therefore, the rules for partnerships will apply. The general rule is that the partnership’s basis in the contributed property is the carryover basis of the contributor. So the $5,000 basis to Baker becomes the carryover $5,000 basis to Apple.
Choices “b”, “c”, and “a” are incorrect per the above rule and per the above computations.
Gulde’s tax basis in Chyme Partnership was $26,000 at the time Gulde received a liquidating distribution of $12,000 cash and land with an adjusted basis to Chyme of $10,000 and a fair market value of $30,000. Chyme did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. What was the amount of Gulde’s basis in the land?
a.
$14,000
b.
$30,000
c.
$0
d.
$10,000
Choice “a” is correct. In a liquidating distribution, we have to “zero out to get out.” Partnership basis starts at $26,000. The cash distribution of $12,000 reduces the partnership basis to $14,000. The land then is distributed with that basis of $14,000, as we zero out to get out.
Choice “c” is incorrect. The correct answer is not zero. It is $14,000, as indicated above.
Choice “d” is incorrect. The land currently has an adjusted basis of $10,000. However, as indicated above, it becomes $14,000 upon liquidation, as we zero out to get out.
Choice “b” is incorrect. The land currently has a FMV of $30,000. However, as indicated above, the basis becomes $14,000 upon liquidation, as we zero out to get out.
In return for a 20% partnership interest, Skinner contributed $5,000 cash and land with a $12,000 basis and a $20,000 fair market value to the partnership. The land was subject to a $10,000 mortgage that the partnership assumed. In addition, the partnership had $20,000 in recourse liabilities that would be shared by partners according to their partnership interests. What amount represents Skinner’s basis in the partnership interest?
a.
$19,000
b.
$27,000
c.
$13,000
d.
$21,000
Choice “c” is correct. Skinner’s basis in partnership interest is calculated as follows:
Cash contributed
$ 5,000
Basis of land contributed
12,000
Less mortgage on land assumed by other partners (80% of $10,000)
(8,000)
Recourse liabilities assumed by Skinner (20% of $20,000)
4,000
Skinner’s basis
$ 13,000
Choices “b”, “d”, and “a” are incorrect per the above calculation.
PDK, LLC had three members with equal ownership percentages. PDK elected to be treated as a partnership. For the tax year ending December 31, Year 1, PDK had the following income and expense items:
Revenues $ 120,000
Interest income 6,000
Gain on sale of securities 8,000
Salaries 36,000
Guaranteed payments 10,000
Rent expense 21,000
Depreciation expense 18,000
Charitable contributions 3,000
What would PDK report as nonseparately stated income for Year 1 tax purposes?
a.
$43,000
b.
$35,000
c.
$51,000
d.
$30,000
Choice “b” is correct. Nonseparately stated income is calculated as follows:
Revenues $ 120,000
Salaries (36,000)
Guaranteed payments (10,000)
Rent expense (21,000)
Depreciation expense (18,000)
Total nonseparately stated income $ 35,000
Note: All other items listed in the question are separately stated.
Choices “d”, “a”, and “c” are incorrect per the above calculation.
When the AQR partnership was formed, partner Acre contributed land with a fair market value of $100,000 and a tax basis of $60,000 in exchange for a one-third interest in the partnership. The AQR partnership agreement specifies that each partner will share equally in the partnership’s profits and losses. During its first year of operation, AQR sold the land to an unrelated third party for $160,000. What is the proper tax treatment of the sale?
a.
The first $40,000 of gain is allocated to Acre, and the remaining gain of $60,000 is shared equally by all the partners in the partnership.
b.
The first $40,000 of gain is allocated to Acre, and the remaining gain of $60,000 is shared equally by the other two partners.
c.
The entire gain of $100,000 must be specifically allocated to Acre.
d.
Each partner reports a capital gain of $33,333.
Choice “a” is correct. The difference between the tax basis of $60,000 and FMV of $100,000 on the date the partnership was formed is a built-in gain to partner Acre. Accordingly, the first $40,000 of gain is allocated to Acre and the remaining gain of $60,000 is then shared equally by all of the partners.
Choices “d”, “c”, and “b” are incorrect per the above explanation.
What is the tax treatment of net losses in excess of the at-risk amount for an activity?
a.
Any loss in excess of the at-risk amount is suspended and is deductible in the year in which the activity is disposed of in full.
b.
Any losses in excess of the at-risk amount are carried back two years against activities with income and then carried forward for 20 years.
c.
Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity.
d.
Any losses in excess of the at-risk amount are deducted currently against income from other activities; the remaining loss, if any, is carried forward without expiration.
Choice “c” is correct. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity. The at-risk amount is also referred to as basis. Note that although we discuss this in the textbook for partnerships, the concept applies to all activities that have flow through income and losses.
Choice “a” is incorrect. This is the rule for suspended passive activity losses, not suspended losses due to at-risk limitations. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity.
Choice “d” is incorrect. Losses in excess of the at-risk amount may not be deducted currently against income from other activities. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity.
Choice “b” is incorrect. Losses in excess of the at-risk amount are not carried back two years against activities with income and then carried forward for 20 years. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity.
Johnson, an individual, has a 50% interest in DEF Partnership. Johnson’s adjusted basis at the beginning of the year was $14,000. The partnership’s ordinary income for the current year was $6,000. Johnson received a nonliquidating distribution of $8,000 cash, and property with an adjusted basis of $12,000 and a fair market value of $15,000. What is the basis of the distributed property, other than cash, to Johnson?
a.
$6,000
b.
$15,000
c.
$12,000
d.
$9,000
Choice “d” is correct. The general rule is that the basis of property received in a nonliquidating distribution is the same as the basis in the hands of the partnership immediately prior to the distribution. However, it is limited to the partner’s basis in the partnership. This property has an adjusted basis to the partnership of $12,000. Johnson’s basis in the partnership at the beginning of the year is $14,000. This is increased by 50% of the ordinary income of $6,000 and reduced by the cash distribution of $8,000. Basis in the partnership is therefore $9,000 ($14,000 + $3,000 – $8,000) before the property distribution. The basis of the property received is limited to the $9,000 partnership basis. Note: This results in Johnson having a zero basis in the partnership after the property distribution.
Choice “a” is incorrect. $6,000 is simply the net income of DEF partnership for the year.
Choice “c” is incorrect. $12,000 would be the adjusted basis of the property if it were not limited to Johnson’s resulting $9,000 basis in the partnership.
Choice “b” is incorrect. $15,000 is the FMV of the property.
Able, an individual, is a partner in CD Partnership with an adjusted basis of $30,000 for Able’s partnership interest. Able received a non-liquidating distribution of $25,000 cash and property with an adjusted basis of $7,000, and a fair market value of $10,000. What amount of gain should Able recognize?
a.
$12,000
b.
$5,000
c.
$2,000
d.
$0
Choice “d” is correct. Gain is recognized only to the extent that cash distributed exceeds the adjusted basis of the partner’s interest in the partnership immediately before the distribution. Able’s basis in the partnership immediately before the distribution is $30,000. The cash distribution is $25,000. This is not in excess of basis and there is a $5,000 basis remaining. Able’s basis in the distributed property is the $5,000 remaining partnership basis.
Choices “c”, “b”, and “a” are incorrect, per the above explanation.
Belson and Forman decided to terminate North partnership. On the date of termination, North’s balance sheet was as follows:
Adjusted basis
Cash $2,000
Equipment (fair market value $4,000) 6,000
Capital—Belson 4,000
Capital—Forman 4,000
Forman’s outside basis is $2,000. The partnership assets were distributed equally between the partners. What is Forman’s tax basis in the property received?
a.
$4,000
b.
$1,000
c.
$10,000
d.
$6,000
Choice “b” is correct. Forman’s basis in the partnership is $2,000 immediately before the liquidating distributions. The assets are divided equally. Forman receives $1,000 of the cash. This reduces the partnership basis to $1,000. Then we “zero out to get out.” Forman’s share of the property will receive a basis of $1,000. This essentially zeroes out the partnership interest.
Choices “a”, “d”, and “c” are incorrect, per the above explanation.
