Section 704

Question 1

How are pre-contribution gains and losses treated?

Answer 1

If a partner contributes property that has an inherent gain or loss at the time of contribution, this built in gain or loss must be taken into account by the contributing partner.

Question 2

Explain Section 704(a) - effect of the partnership agreement

Answer 2

A partner’s distributive share of income, gain, deduction, or credit shall, except as otherwise provided, be determined by the partnership agreement

Question 3

Explain Section 704(b) - determination of distributive share

Answer 3

A partner’s distributive share of income, g/l, deduction, or credit shall be determined in accordance with the partner’s interest in the partnership if
1) the partnership agreement does not provide
2) the allocation to a partner does not have substantial economic effect

Question 4

Explain the substantial economic effect test

Answer 4

A 2 Part Test:

1) Economic test: An allocation to have economic effect must be consistent with the underlying economic arrangement of the partners. The partner must bear the economic benefit or burden of the allocation.
a) must maintain capital accounts
b) liquidating distributions must be made in accordance with positive capital accounts
c) Unlimited deficit restoration - obligation to restore deficit account, partner must add cash to restore basis. Alternate test - LPA contain a “qualified income offset” provision

2) Substantiality test: an allocation is substantial if there is a reasonable possibility that the allocation will affect substantially the dollar amounts to be received by the partners (i.e. you can’t just cherry-pick your tax consequences)

Question 4

Explain the substantial economic effect test

Answer 4

A 2 Part Test:

1) Economic test: An allocation to have economic effect must be consistent with the underlying economic arrangement of the partners. The partner must bear the economic benefit or burden of the allocation.
a) must maintain capital accounts
b) liquidating distributions must be made in accordance with positive capital accounts
c) Unlimited deficit restoration - obligation to restore deficit account, partner must add cash to restore basis. Alternate test - LPA contain a “qualified income offset” provision

2) Substantiality test: an allocation is substantial if there is a reasonable possibility that the allocation will affect substantially the dollar amounts to be received by the partners (i.e. you can’t just cherry-pick your tax consequences)