V. Federal Taxation of Entities - 4. Partnership Taxation

Question 1

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

Answer 1

II. Partnership Definition

C. Certain publicly traded partnerships (i.e., master limited partnerships) are taxed as corporations.

VI. Formations

B. Deferred Gain or Loss

3. No deferral is available for contributions to a partnership in exchange for property—deferral is only available for exchanges of property for a partnership interest.

Question 2

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

VII. Basis Issues at Formation

Answer 2

Each partner calculates his or her personal adjusted basis (outside basis) in the partnership, and the partnership calculates the adjusted basis of the assets (inside basis) held by the partnership.

1. Inside Basis of Property: The aggregate basis of assets in the hands of the partnership.
2. Outside Basis of Property: The adjusted basis of each partners’ interest in the partnership.

Question 3

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

IX. Computation of Basis of Partnership Interest—Partners continually adjust their outside basis for partnership transactions, including the deduction of their share of partnership losses.

Answer 3

A. Increases—A partner’s basis is increased by contributions of property, income, and increases in liabilities.

1. A partner’s proportionate share of income includes gains and exempt income.
2. A partner’s proportionate share includes increases in liabilities (treated like a contribution).

B. Decreases—A partner’s basis is decreased by distributions, expenses, and deemed distributions.

1. A partner’s proportionate share of expenses, including deductions, losses, and nondeductible expenses (not capital expenditures)
2. A partner’s proportionate share of decreases in liabilities (deemed distributions)

Example

Partner R, a 25% partner, contributes property to the partnership with an adjusted basis of $20, FMV of $50, and a liability of $30 which the partnership assumes. R’s basis is first increased by $20 for the basis of the property, then decreased by $30 for the debt assumption. However, since the partnership debt increased by $30, and R is responsible for 25% of the debt, or $7.50, his basis is increased by $7.50. The net effect on basis is a decrease of $2.50 (basis of $20 less $22.50 of debt shifted to other partners).

If R’s basis before this contribution was $0, he would recognize $2.50 of gain to avoid negative basis. If R’s basis before the contribution was $10, his ending basis would be $7.50 ($10 − $2.50).

Question 4

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

IX. Computation of Basis of Partnership Interest—Partners continually adjust their outside basis for partnership transactions, including the deduction of their share of partnership losses.

Answer 4

C. Debt Allocations—Changes in Liabilities Affect a Partner’s Basis.

1. An increase in the partnership’s liabilities (e.g., loan from a bank, increase in accounts payable) increases each partner’s basis in the partnership by each partner’s share of the increase.
2. Any decrease in the partnership’s liabilities is considered to be a distribution of money to each partner and reduces each partner’s basis in the partnership by each partner’s share of the decrease.
3. Any decrease in a partner’s individual liability by reason of the assumption by the partnership of such individual liabilities is considered to be a distribution of money to the partner by the partnership (i.e., partner’s basis is reduced).
4. Any increase in a partner’s individual liability by reason of the assumption by the partner of partnership liabilities is considered to be a contribution of money to the partnership by the partner. Thus, the partner’s basis is increased.

Question 5

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

IX. Computation of Basis of Partnership Interest—Partners continually adjust their outside basis for partnership transactions, including the deduction of their share of partnership losses.

C. Debt Allocations—Changes in Liabilities Affect a Partner’s Basis.

Answer 5

Example

The XYZ partnership owns a warehouse with an adjusted basis of $120,000 subject to a mortgage of $90,000. Partner X (one of three equal partners) has a basis for his partnership interest of $75,000. If the partnership transfers the warehouse and mortgage to Partner X as a current distribution, X’s basis for his partnership interest immediately following the distribution would be $15,000, calculated as follows:

Beginning basis $75,000

Individual assumption of mortgage +90,000

$165,000

Distribution of warehouse -120,000

Partner’s share of decrease

in partnership’s liabilities - 30,000

Basis after distribution$15,000

Assume that one of the other one-third partners had a basis of $75,000 immediately before the distribution. What would the partner’s basis be immediately after the distribution to Partner X? The partner’s basis would be $45,000 (i.e., $75,000 less one-third of the $90,000 decrease in partnership liabilities).

Question 6

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

IX. Computation of Basis of Partnership Interest

C. Debt Allocations—Changes in Liabilities Affect a Partner’s Basis.

Answer 6

1. Recourse debt—For recourse debt, each partner’s share of debt is measured by his or her economic risk of loss assuming a constructive liquidation scenario occurred. While this material is likely too complex for the exam, you should be aware that limited partners are not allocated any share of recourse debt.
2. Nonrecourse debt—This is debt for which the lender’s only recourse, in the event of default, is to take back the property. As above, the allocation of nonrecourse debt is likely too complex for the exam. However, you should be aware that nonrecourse debt is often allocated based on the partners’ profit sharing ratios. Also, contrasted with recourse debt, both general and limited partners are allocated nonrecourse debt.

Question 7

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

IX. Computation of Basis of Partnership Interest

E. Summary—See the following calculation of outside basis.

Answer 7

Beginning Basis

Plus:

Contributions

Partner’s share of: Debt Increases

Partnership Income

Exempt Income

Less:

Distributions: Cash Distributions

Property Distributions

Partner’s share of: Nondeductible Expenses

Expenses and Losses

Debt Decreases

Ending basis

Question 8

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

X. Capital Account

Answer 8

1. While basis represents one’s investment in a partnership for tax purposes, capital account represents the amount a partner should receive when the partnership is liquidated.
2. Basis and capital account are computed in a similar fashion, except:
   
   1. Liabilities of the partnership do not affect the capital account.
   2. The fair market value of contributions and distributions impact the capital account, rather than the tax basis.

Question 9

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

XI. Permitted Tax Years—Partners report income in the year that the partnership tax year ­ends.

• Since the partnership and the partners may not have the same year-ends, the partners only report income once the partnership closes its books at the partnership year-end.

Answer 9

Example

ABC is a partnership with a June 30 fiscal year-end. Partner A, however, has a calendar year-end. This year ABC earned $24,000 for the fiscal year and also earned an additional $9,000 from July through December. If A is an equal partner in ABC, he should report $8,000 of income this year (one-third of $24,000). A’s share of the income from July through December will not be taxed until ABC closes its books next year.

Question 10

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

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?

1. $ 2,000
2. $ 5,000
3. $ 8,000
4. $ 10,000

Answer 10

B.

Upon a partnership formation the partnership’s basis in the assets received from the contributing partners is the basis in the hands of the partner. Thus, Apple’s basis is $5,000.

Question 11

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

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

1. Be a limited partnership.
2. Be a member of a tiered structure.
3. Choose a tax year where the deferral period is no longer than three months.
4. Have less than 35 partners.

Answer 11

C.

Under Code Section 444, partnerships, S corporations and personal service companies may elect to have a tax year that differs from their required tax year, provided the tax year chosen does not have a deferral period of longer than three months.

Partnerships and S corporations making the election must approximate the amount of tax to partners and S corporations that is attributable to income earned in the short period and make required payments of that amount.

Question 12

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

A partner received a partnership interest with a fair market value (FMV) of $55,000 in exchange for the following items:

Basis FMV

Cash $20,000 $20,000

Property 10,000 30,000

Services rendered 0 5,000

What is the partner’s basis in the partnership interest?

1. $55,000
2. $50,000
3. $35,000
4. $30,000

Answer 12

C.

The partner received a partnership interest in return for property and services. His basis in his partnership for the property contributed is equal to the basis of the property he contributed, or $30,000 ($20,000 + $10,000). For the services rendered he must recognize $5,000 of income for the interest received, so he has a $5,000 basis in that portion of his partnership interest. His total basis in the partnership interest is $35,000 ($30,000 + $5,000).

Question 13

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

Juan contributed land with a basis of $10,000 and a fair market value of $15,000 to the Sounds Partnership. He also contributed services with a value of $25,000. In return, he received a partnership interest in Sounds with a value of $40,000.

What is Juan’s basis in his partnership interest?

1. $0
2. $10,000
3. $35,000
4. $40,000

Answer 13

C.

Juan receives basis in his partnership interest equal to the basis of the property contributed. He also must recognize $25,000 of wage income for receiving a portion of the partnership interest in return for services rendered. Therefore, he also receives $25,000 of basis for this income recognition. Thus, his total basis is $10,000 + $25,000, or $35,000.

Question 14

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

A $100,000 increase in partnership liabilities is treated in which of the following ways?

1. Increases each partner’s basis in the partnership by $100,000.
2. Increases the partners’ bases only if the liability is nonrecourse.
3. Increases each partner’s basis in proportion to their ownership.
4. Does not change any partner’s basis in the partnership regardless of whether the liabilities are recourse or nonrecourse.

Answer 14

C.

Partners increase their bases in their partnership interests by their respective share of the partnership’s debt, both recourse and nonrecourse.

Question 15

V. Federal Taxation of Entities - 4. Partnership Taxation

125. Formation and Basis

On June 1, 2019, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock’s net assets at that date had a basis of $70,000 and a fair market value of $100,000.

In Kelly’s 2019 income tax return, what amount must Kelly include as income from transfer of partnership interest?

1. $7,000 ordinary income
2. $7,000 capital gain
3. $10,000 ordinary income
4. $10,000 capital gain

Answer 15

C.

When an individual contributes services to a partnership for a capital interest in the partnership, the individual reports taxable income equal to the fair market value of the transferred capital interest.

Capital interests received are treated as guaranteed payments, which means the capital interest is viewed a salary payment and, as such, reported as ordinary income by the partner.

Since the fair market value of the partnership’s net assets is $100,000 and Kelly contributed services for a 10% interest in the partnership, Kelly must recognize $10,000 of ordinary income.

Question 16

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

II. Distributive Share

common examples of separately stated items to each partner on Schedule K-1.

Answer 16

1. Capital gains and losses
2. Section 1231 gains and losses
3. Charitable contributions
4. Foreign income taxes
5. Section 179 expense deduction
6. Interest, dividend, and royalty income
7. Interest expense on investment indebtedness
8. Net income (loss) from rental real estate activity
9. Net income (loss) from other rental activity
10. Tax-exempt income

Question 17

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

II. Distributive Share

ordinary income and deductions (non-separately stated items)

Answer 17

1. Sales less cost of goods sold
2. Business expenses such as wages, rents, bad debts, and repairs
3. Deduction for guaranteed payments to partners
4. Depreciation
5. Amortization (over 180 months) of partnership organization and start-up expenditures
6. Section 1245 and 1250, recapture

Question 18

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

II. Distributive Share

6. The character of any gain or loss recognized on the disposition of property is generally determined by the nature of the property in the hands of the partnership. However, for contributed property, the character may be based on the nature of the property to the contributing partner before contribution.

Answer 18

1. If a partner contributes unrealized receivables, the partnership will recognize ordinary income or loss on the subsequent disposition of the unrealized receivables.
2. If the property contributed was inventory property to the contributing partner, any gain or loss recognized by the partnership on the disposition of the property within five years will be treated as ordinary income or loss.
3. If the contributed property was a capital asset, any loss later recognized by the partnership on the disposition of the property within five years will be treated as a capital loss to the extent of the contributing partner’s unrecognized capital loss at the time of contribution. This rule applies to losses only, not to gains.

Question 19

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

II. Distributive Share

7. Partnerships may use the cash basis of accounting unless the partnership is a “tax shelter” or at least one partner is a C corporation. Exceptions allow the cash method for farming and where the partnership (or corporate partner) is a small business (average annual gross receipts of $25 million or less for the three prior years ending with the current tax year).

Answer 19

C. Loss Limitations

Example

Robin is single and has the following results from her trades and businesses:

Horse-breeding sole proprietorship ($275,000)

Partnership distributive share ($ 75,000)

S corporation distributive share $ 50,000

The aggregate new loss from all of Robin’s trades and businesses is $300,000, which exceeds the maximum deductible loss of $250,000. Her deduction is limited to $250,000, and the remaining $50,000 loss is added to her NOL carryforward for the year.

Question 20

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

What is the tax treatment of net losses in excess of the at-risk amount for an activity?

1. 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.
2. 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.
3. 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.
4. 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.

Answer 20

2.

Question 21

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

Dale’s distributive share of income from the calendar-year partnership of Dale & Eck was $50,000 in 2019. On December 15, 2019, Dale, who is a cash-basis taxpayer, received a $27,000 distribution of the partnership’s 2019 income, with the $23,000 balance paid to Dale in May 2020.

In addition, Dale received a $10,000 interest-free loan from the partnership in 2019.

This $10,000 is to be offset against Dale’s share of 2019 partnership income.

What total amount of partnership income is taxable to Dale in 2019?

1. $23,000
2. $37,000
3. $50,000
4. $60,000

Answer 21

3.

Partners must report their share of the partnership’s income, deductions and other items on the partner’s income tax return in the calendar year in which the partnership’s tax year ends. Dale’s share of Dale and Eck’s 2019 income was $50,000. Thus, Dale must report $50,000 of partnership income in 2019.

Question 22

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

Don Wolf became a general partner in Gata Associates on January 1, 2019, with a 5% interest in Gata’s profits, losses, and capital.

Gata is a distributor of auto parts. Wolf does not materially participate in the partnership business. For the year ended December 31, 2019, Gata had an operating loss of $100,000. In addition, Gata earned interest of $20,000 on a temporary investment. Gata has kept the principal temporarily invested while awaiting delivery of equipment that is presently on order. The principal will be used to pay for this equipment.

Wolf’s passive loss for 2019 is

1. $0.
2. $4,000.
3. $5,000.
4. $6,000.

Answer 22

3.

Passive activity losses are the amount that total losses from passive activities exceed total gains from passive activities. The characterization of a partner’s share of the partnership’s income as passive or nonpassive depends on the partner’s participation in the partnership’s income earning activities.

Since Wolf did not materially participate in the partnership business, his share of the partnership’s operating loss, $5,000, is considered a loss from a passive activity. Passive income does not include portfolio income.

As a result, Wolf’s share of the $20,000 in interest income would not be passive. Therefore, since Wolf had no gains from passive activities to offset the loss from his share of the partnership’s operating loss, Wolf would have a passive loss of $5,000, equal to his share of the partnership’s operating loss.

Question 23

V. Federal Taxation of Entities - 4. Partnership Taxation

126. Flow-Through of Income and Losses

An individual is a 50% partner who materially participates in Stone Partnership. The individual’s adjusted basis at the beginning of the year was $0. Stone had a $70,000 loss from its business. Stone borrowed $30,000 from a bank of which $20,000 remained unpaid at year-end. What amount of loss is the individual allowed in the current year from Stone?

1. $35,000
2. $15,000
3. $10,000
4. $0

Answer 23

3.

Beginning basis jn partnership interest$ 0

Share of partnership debt ($20,000 × 50%)10,000

Basis before loss flow-through$10,000

Portion of $35,000 ($70,000 × 50%) loss allowed(10,000)

Ending basis in partnership interest$ 0

Loss allowed to be deducted on Form 1040 is limited to basis in partnership interest.

Question 24

V. Federal Taxation of Entities - 4. Partnership Taxation

127. Transactions with Partners

II. Precontribution (Built-In) Gains and Losses—These are allocated back to the original contributing partners when the property is sold.

1. Sales of contributed ordinary income or loss property (e.g., inventory and accounts receivable) generate ordinary income or loss to the contributing partner. The characterization of income or loss as ordinary from a sale of inventory is limited to five years (five years after the property was contributed to the partnership). There is no time limit for the ordinary income characterization for accounts receivables.

Note that all gain or loss on the sale is treated as ordinary if the above rule is met. It is not limited to the built-in gain or loss at the time of contribution.

Answer 24

Example

Partner A is an art dealer and a partner in ABC Partners, a consulting firm. A contributes a painting (he held as inventory) to ABC to decorate the ABC office (a Section 1231 asset). The painting has a FMV of $10,000 and an adjusted basis of $6,000. If ABC sells the painting within five years of the contribution, any gain or loss will be allocated to A (up to the built-in gain or loss) and will be characterized as ordinary income. Thus, if the painting is sold four year later for $11,000, the $5,000 gain ($11,000 − $6,000) is characterized as ordinary income. If ABC sells the painting after five years, then the $5,000 gain is Section 1231 gain. Note that in both cases, since the built-in gain was only $4,000 ($10,000 − $6,000), the first $4,000 of gain is allocated to Partner A. The remaining $1,000 of gain is allocated to A and the other partners based on their profit-sharing ratios.

Question 25

V. Federal Taxation of Entities - 4. Partnership Taxation

127. Transactions with Partners

II. Precontribution (Built-In) Gains and Losses—These are allocated back to the original contributing partners when the property is sold.

2. Sales of contributed capital assets with built-in capital losses generate capital losses to contributing partners (again only for five years after the contribution). However, for built-in capital losses, the amount of loss that can be recharacterized as capital is limited to the built-in loss at the time the asset was contributed.

Answer 25

Example

Partner R contributes a capital asset to RST Partnership, which will be used by the partnership as inventory. The asset has a FMV of $10,000 and adjusted basis of $15,000. The built-in loss is $5,000 and, when this asset is sold, the first $5,000 of recognized loss will be allocated to R. If RST sells the asset three years later for $8,000, the recognized loss is $7,000. The first $5,000 of loss is allocated to R and the other $2,000 of loss is allocated to R and the other partners based on their loss- sharing ratios. The $5,000 loss allocated to R is a capital loss (since this was sold within five years), but the remaining $2,000 loss will be characterized based on how the partnership used the asset (Inventory = Ordinary loss). Note, that only the built-in loss is recharacterized as a capital loss.

Question 26

V. Federal Taxation of Entities - 4. Partnership Taxation

127. Transactions with Partners

III. Related Party Rules

Constructive ownership rules apply in determining whether a transaction involves a more than 50% owned partnership. For this purpose, an individual’s family includes brothers and sisters, spouse, ancestors, and lineal descendants.

Answer 26

1. No losses are deductible from sales or exchanges of property between related party
2. A gain recognized on a sale or exchange of property between related party
3. No deduction for a payment to a partner can be claimed by an accrual partnership until the cash basis partner includes the payment in income. Note that this applies to all partners (not just those owning more than 50%).

Question 27

V. Federal Taxation of Entities - 4. Partnership Taxation

127. Transactions with Partners

IV. Partners are generally not considered to be employees for purposes of employee fringe benefits (e.g., cost of $50,000 of group-term life insurance, exclusion of premiums or benefits under an employer accident or health plan, etc.). The value of a partner’s fringe benefits are deductible by the partnership as guaranteed payments and must be included in a partner’s gross income.

Question 28

V. Federal Taxation of Entities - 4. Partnership Taxation

127. Transactions with Partners

At December 31, 2018, Lincoln and Ebert were equal partners in a partnership with net assets having a tax basis and fair market value of $150,000. On January 2, 2019, Gregory contributed securities with a fair market value of $75,000 (purchased in 2014 at a cost of $51,000) to become an equal partner in the new firm of Lincoln, Ebert, and Gregory. The securities were sold on July 1, 2019, for $78,000. How much of the partnership’s capital gain from the sale of these securities should be allocated to Gregory?

1. $0
2. $ 9,000
3. $24,000
4. $25,000

Answer 28

D.

Since the securities were sold for more than their fair market value on the date of contribution, the entire pre-contribution gain of $24,000 ($75,000 − $51,000) would be allocated to Gregory. In addition, Gregory would be allocated 1/3 of the post-contribution gain from the securities, which is $1,000 [($78,000 − $75,000) × 1/3]. Gregory should therefore be allocated $25,000 ($24,000 + $1,000) of the partnership’s capital gain.

Question 29

V. Federal Taxation of Entities - 4. Partnership Taxation

128. Partnership Distributions

II. Nonliquidating (or Current) Distributions

1. Nonliquidating distributions of property never trigger loss recognition, but losses may be recognized on a liquidating distribution
2. Basis Effects—For partners, nonliquidating distributions are a return of capital that reduces outside basis (in a specific order).

Answer 29

Example

Casey had a basis of $9,000 for his partnership interest at the time that he received a nonliquidating partnership distribution consisting of $5,000 cash and other property with a basis of $3,000 and an FMV of $8,000. No gain is recognized by Casey since the cash received did not exceed his partnership basis. Casey’s $9,000 basis for his partnership interest is first reduced by the $5,000 cash and then reduced by the $3,000 basis of other property, to $1,000. Casey will have a basis for the other property received of $3,000.

5.If the distributed property consists of multiple assets, then the allocation of basis can be quite complex. A simple approach is to allocate the outside basis by the amount of the inside basis.

Example

Two parcels of inventory (Parcel A and Parcel B) are distributed to a partner in a nonliquidating proportionate distribution at a time when the partner has an outside basis of $12. Parcel A has an inside basis of $6 and Parcel B has an inside basis of $18. Each parcel is worth $20. In this situation, one-fourth [($6/($6 + $18) × $12] or $3 of the outside basis is allocated to parcel A. The remaining three-fourths of the outside basis ($9) is allocated to parcel B [$18/($6 + $18) × $12].

Question 30

V. Federal Taxation of Entities - 4. Partnership Taxation

128. Partnership Distributions

III. Liquidating Distributions

Unlike nonliquidating distributions, partners can recognize losses on liquidating distributions, but only if two conditions are met:

1. First, the distribution must consist only of cash, inventory, and unrealized receivables.
2. Second, the outside basis of the partner’s interest exceeds the sum of cash plus the inside basis of the receivables and inventory.

Answer 30

Examples

1. Day had a basis of $20,000 for his partnership interest before receiving a distribution in complete liquidation of his interest. The liquidating distribution consisted of $6,000 cash and inventory with a basis of $11,000. Since Day’s liquidating distribution consisted of only money and inventory, Day will recognize a loss on the liquidation of his partnership interest. The amount of loss is the $3,000 difference between the $20,000 basis for his partnership interest and the $6,000 cash and the $11,000 basis for the inventory received. Day will have an $11,000 basis for the inventory.
2. Assume the same facts as in Example #1 except that Day’s liquidating distribution consists of $6,000 cash and a parcel of land with a basis of $11,000. Since the liquidating distribution now includes property other than money, receivables, and inventory, no loss can be recognized on the liquidation of Day’s partnership interest. The basis for Day’s partnership interest is first reduced by the $6,000 cash to $14,000. Since no loss can be recognized, the parcel of land must absorb all of Day’s unrecovered partnership basis. As a result, the land will have a basis of $14,000.

Question 31

V. Federal Taxation of Entities - 4. Partnership Taxation

128. Partnership Distributions

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?

1. $96,000
2. $83,000
3. $80,000
4. $70,000

Answer 31

C

A partner’s basis in property distributed in a complete liquidation of the partner’s partnership interest equals the partner’s partnership interest less any cash distributed in the transaction.

Thus, Vance’s basis in the real estate is $80,000, the adjusted basis of Vance’s partnership interest in Lex Associates of $180,000 less cash received of $100,000.

Question 32

V. Federal Taxation of Entities - 4. Partnership Taxation

128. Partnership Distributions

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?

1. $5,000
2. $25,000
3. $35,000
4. $40,000

Answer 32

C

The partner must report $25,000 of ordinary income and the $10,000 guaranteed payment. The distribution does not generate additional income since the partner has sufficient basis to absorb it.

Question 33

V. Federal Taxation of Entities - 4. Partnership Taxation

128. Partnership Distributions

Garner is a 25 percent partner in Classic General Partnership. On February 3, Garner’s tax basis in Classic was $10,000 when she received a nonliquidating distribution of $5,000 cash. Classic had no unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. Classic reported the following for the same year:

U.S. Treasury interest $ 30,000

Ordinary business income 120,000

What amount of income from Classic should Garner include in her gross income for that year?

1. $ 7,500
2. $30,000
3. $37,500
4. $42,500

Answer 33

C

$7,500 of the interest ($30,000 × 25%) and $30,000 of the business income ($120,000 × 25%) is taxed on Garner’s tax return. The $5,000 distribution reduces Garner’s basis in Classic but does not produce any income since the cash distribution does not exceed the basis.

Question 34

V. Federal Taxation of Entities - 4. Partnership Taxation

128. Partnership Distributions

Morse is a 50% partner in Ecco Partnership. Morse’s tax basis in Ecco on January 2 was $4,000. Ecco did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. On December 31, Ecco made an $11,000 nonliquidating cash distribution to Morse. For the year, Ecco reported $10,000 of ordinary business income. What is the amount of the net capital gain realized by Morse from the cash distribution?

1. $0
2. $2,000
3. $7,000
4. $11,000

Answer 34

B

Gain is recognized from a partnership distribution if the cash distributed to the partner exceeds her basis in her partnership interest. Morse’s basis of $4,000 is increased by her share of the partnership’s ordinary income, or $5,000 ($10,000 × 50%), increasing her basis to $9,000. The cash distribution of $11,000 exceeds her basis of $9,000 by $2,000. So Morse has a $2,000 capital gain.

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Question 35

V. Federal Taxation of Entities - 4. Partnership Taxation

129. Sales and Terminations

I. Sales of Partnership Interests

B. Hot Assets

1. If the partnership has hot assets at the time a partnership interest is sold, the selling partner must allocate a portion of the sale proceeds to these assets and recognize ordinary income.
2. Hot assets are a) unrealized receivables (receivables of a cash basis taxpayer; includes depreciation recapture), and b) inventory.
   Definition
   Inventory: All assets other than cash, capital assets, and Section 1231 assets.

Answer 35

3. The remaining sale proceeds are allocable to the selling partner’s capital asset interest and result in a capital gain or loss.

Example

X has a 40% interest in the XY Partnership. Partner X sells his 40% interest to Z for $50,000. X’s basis in his partnership is $22,000, and the cash-method partnership had the following receivables and inventory:

Adjusted Basis Fair Market Value

Accounts receivable 0 $10,000

Inventory 4,000 10,000

Potential Section 1250 recapture   0  10,000

$4,000 $30,000

X’s total gain is $28,000 (i.e., $50,000 – $22,000). Since the Section 1250 recapture is treated as “unrealized receivables” and the inventory is appreciated, X will recognize ordinary income to the extent that his selling price attributable to Section 751 items ($30,000 × 40% = $12,000) exceeds his basis in those items ($4,000 × 40% = $1,600), that is, $10,400. The remainder of X’s gain ($28,000 – $10,400 = $17,600) will be treated as capital gain.

Question 36

V. Federal Taxation of Entities - 4. Partnership Taxation

129. Sales and Terminations

I. Sales of Partnership Interests

D. Section 754 election

Answer 36

Assume X sells his 40% interest to Z for $80,000 when the partnership balance sheet reflects the following:

XY Partnership

Basis FMV

Assets

Accounts Receivable $0 $100,000

Real Property 30,000 100,000

X(40%) $80,000

Y(60%) 120,000

Z will have a basis for his partnership interest of $80,000, while his share of the adjusted basis of partnership property will be only $12,000. If the partnership elects to adjust the basis of partnership property, it will increase the basis of its assets by $68,000 ($80,000 – $12,000) solely for the benefit of Z. The basis of the receivables will increase from 0 to $40,000 with the full adjustment allocated to Z. When the receivables are collected, Y will have $60,000 of income and Z will have none. The basis of the real property will increase by $28,000 to $58,000, so that Z’s share of the basis will be $40,000 (i.e., $12,000 + $28,000).

Question 37

V. Federal Taxation of Entities - 4. Partnership Taxation

129. Sales and Terminations

II. Terminations

C. Mergers and Divisions

Answer 37

1. Merger

Partnerships AB and CD merge on April 1, forming the ABCD Partnership in which the partners’ interests are as follows: Partner A, 30%; B, 30%; C, 20%; and D, 20%. Partnership ABCD is a continuation of the AB Partnership. The CD Partnership is considered terminated and its taxable year closed on April 1.

2. Division

Partnership ABCD is owned as follows: A, 40%; and B, C, and D each own a 20% interest. The partners agree to separate and form two partnerships—AC and BD. Partnership AC is a continuation of ABCD. BD is considered a new partnership and must adopt a taxable year as well as make any other necessary tax accounting elections.

Question 38

V. Federal Taxation of Entities - 4. Partnership Taxation

129. Sales and Terminations

On December 31, 2019, 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?

1. Ordinary loss of $10,000
2. Ordinary gain of $15,000
3. Capital loss of $10,000
4. Capital gain of $15,000

Answer 38

D.

If a partner sells his/her interest in the partnership, the partner recognizes a capital gain equal to the amount that the payment exceeds the partner’s adjusted basis in the partnership.

Clark’s adjusted basis in the partnership is $40,000 immediately before the sale. His amount realized is $55,000 ($30,000 cash received + $25,000 debt relief). Hence, Clark must recognize a capital gain of $15,000 ($55,000 − $40,000).

Question 39

V. Federal Taxation of Entities - 4. Partnership Taxation

129. Sales and Terminations

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.

1. I only.
2. II only.
3. Both I and II.
4. Neither I nor II.

Answer 39

C.

For tax purposes, a partnership terminates when it stops doing business as a partnership.

When the partnership’s business and financial operations are continued by other members, there is a deemed distribution of assets to the remaining partners and the purchaser and a hypothetical recontribution of assets to a new partnership.