Forming And Operating Partnerships
Forming and Operating Partnerships
Solutions to Problems
- [LO 2] Joseph contributed $22,000 in cash and equipment with a tax basis of $5,000 and a fair market value of $11,000 to Berry Hill Partnership in exchange for a partnership interest.
a. What is Joseph’s tax basis in his partnership interest?
b. What is Berry Hill’s basis in the equipment?.
- [ LO 2] Lance contributed investment property worth $500,000, purchased three years ago for $200,000 cash, to Cloud Peak LLC in exchange for an 85 percent profits and capital interest in the LLC. Cloud Peak owes $300,000 to its suppliers but has no other debts.
a. What is Lance’s tax basis in his LLC interest?
b. What is Lance’s holding period in his interest?
c. What is Cloud Peak’s basis in the contributed property?
d. What is Cloud Peak’s holding period in the contributed property?
- [ LO 2] Laurel contributed equipment worth $200,000, purchased 10 months ago for $250,000 cash and used in her sole proprietorship, to Sand Creek LLC in exchange for a 15 percent profits and capital interest in the LLC. Laurel agreed to guarantee all $15,000 of Sand Creek’s accounts payable, but she did not guarantee any portion of the $100,000 nonrecourse mortgage securing Sand Creek’s office building. Other than the accounts payable and mortgage, Sand Creek does not owe any debts to other creditors.
a. What is Laurel’s initial tax basis in her LLC interest?
b. What is Laurel’s holding period in her interest?
c. What is Sand Creek’s initial basis in the contributed property?
d. What is Sand Creek’s holding period in the contributed property?
- [LO 2] {Planning}Harry and Sally formed the Evergreen partnership by contributing the following assets in exchange for a 50 percent capital and profits interest in the partnership:
Harry: BasisFair Market Value
Cash $ 30,000 $ 30,000
Land 100,000 120,000
Totals $ 130,000 $ 150,000
Sally:
Equipment used in a business 200,000 150,000
Totals $ 200,000 $ 150,000
a. How much gain or loss will Harry recognize on the contribution?
b. How much gain or loss will Sally recognize on the contribution?
c. How could the transaction be structured a different way to get a better result for Sally?
d. What is Harry’s tax basis in his partnership interest?
e. What is Sally’s tax basis in her partnership interest?
f. What is Evergreen’s tax basis in its assets?
g. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the Evergreen partnership showing the tax capital accounts for the partners.
- [LO 2] Cosmo contributed land with a fair market value of $400,000 and a tax basis of $90,000 to the Y Mountain partnership in exchange for a 25 percent profits and capital interest in the partnership. The land is secured by $120,000 of nonrecourse debt. Other than this nonrecourse debt, Y Mountain partnership does not have any debt.
a. How much gain will Cosmo recognize from the contribution?
b. What is Cosmo’s tax basis in his partnership interest?
- [LO2] When High Horizon LLC was formed, Maude contributed the following assets in exchange for a 25 percent capital and profits interest in the LLC:
Maude: BasisFair Market Value
Cash $ 20,000 $ 20,000
Land* 100,000 360,000
Totals $ 120,000 $ 380,000
*Nonrecourse debt secured by the land equals $160,000
James, Harold and Jenny each contributed $220,000 in cash for a 25% profits and capital interest.
a. How much gain or loss will Maude and the other members recognize?
b. What is Maude’s tax basis in her LLC interest?
c. What tax basis do James, Harold, and Jenny have in their LLC interests?
d. What is High Horizon’s tax basis in its assets?
e. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the High Horizon LLC showing the tax capital accounts for the members
- [LO2] Kevan, Jerry, and Dave formed Albee LLC. Jerry and Dave each contributed $245,000 in cash. Kevan contributed the following assets:
Kevan: BasisFair Market Value
Cash $ 15,000 $ 15,000
Land* 120,000 440,000
Totals $ 135,000 $ 455,000
*Nonrecourse debt secured by the land equals $210,000
Each member received a one-third capital and profits interest in the LLC.
a. How much gain or loss will Jerry, Dave and Kevan recognize on the contributions?
b. What is Kevan’s tax basis in his LLC interest?
c. What tax basis do Jerry and Dave have in their LLC interests?
d. What is Albee LLC’s tax basis in its assets?
e. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the Albee LLC showing the tax capital accounts for the members. What is Kevan’s share of the LLC’s inside basis?
f. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to guarantee 33.33 percent of the debt and Jerry to guarantee the remaining 66.67 percent of the debt when Albee LLC was formed, how much gain or loss will Kevan recognize?
a. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to guarantee 33.33 percent of the debt and Jerry to guarantee the remaining 66.67 percent of the debt when Albee LLC was formed, what are the members’ tax bases in their LLC interests?
- [LO2] {Research} Jim has decided to contribute some equipment he previously used in his sole proprietorship in exchange for a 10 percent profits and capital interest in Fast Choppers LLC. Jim originally paid $200,000 cash for the equipment. Since then, the tax basis in the equipment has been reduced to $100,000 because of tax depreciation, and the fair market value of the equipment is now $150,000.
a. Must Jim recognize any of the potential § 1245 recapture when he contributes the machinery to Fast Choppers? {Hint:See § 1245(b)(3).}
b. What cost recovery method will Fast Choppers use to depreciate the machinery? {Hint: See § 168(i)(7).}
c. If Fast Choppers were to immediately sell the equipment Jim contributed for $150,000, how much gain would Jim recognize and what is its character? {Hint: See § 1245 and 704(c).}
.
- [LO2] {Research} Ansel purchased raw land three years ago for $200,000 to hold as an investment. After watching the value of the land drop to $150,000, he decided to contribute it to Mountainside Developers LLC in exchange for a 5 percent capital and profits interest. Mountainside plans to develop the property and will treat it as inventory, like all of the other real estate it holds.
a. If Mountainside sells the property for $150,000 after holding it for one year, how much gain or loss does it recognize, and what is the character of its gain or loss? {Hint: See §724.}
b. If Mountainside sells the property for $125,000 after holding it for two years, how much gain or loss does it recognize, and what is the character of the gain or loss?
a. If Mountainside sells the property for $150,000 after holding it six years, how much gain or loss is recognized, and what is the character of the gain or loss?
b.
- [LO2] {Research} Claude purchased raw land three years ago for $1,500,000 to develop into lots and sell to individuals planning to build their dream homes. Claude intended to treat this property as inventory, like his other development properties. Before completing the development of the property, however, he decided to contribute it to South Peak Investors LLC when it was worth $2,500,000, in exchange for a 10 percent capital and profits interest. South Peak’s strategy is to hold land for investment purposes only and then sell it later at a gain.
a. If South Peak sells the property for $3,000,000 four years after Claude’s contribution, how much gain or loss is recognized and what is its character? {Hint:See § 724.}
b. If South Peak sells the property for $3,000,000 five and one-half years after Claude’s contribution, how much gain or loss is recognized and what is its character?
- [LO2] {Research} Reggie contributed $10,000 in cash and a capital asset he had held for three years with a fair market value of $20,000 and tax basis of $10,000 for a 5 percent capital and profits interest in Green Valley LLC.
a. If Reggie sells his LLC interest thirteen months later for $30,000 when the tax basis in his partnership interest is still $20,000, how much gain does he report and what is its character?
b. If Reggie sells his LLC interest two months later for $30,000 when the tax basis in his partnership interest is still $20,000, how much gain does he report and what is its character? {Hint: See Reg. §1.1223-3}
- [LO2] Connie recently provided legal services to the Winterhaven LLC and received a 5 percent interest in the LLC as compensation. Winterhaven currently has $50,000 of accounts payable and no other debt. The current fair market value of Winterhaven’s capital is $200,000.
a. If Connie receives a 5 percent capital interest only, how much income must she report, and what is her tax basis in the LLC interest?
b. If Connie receives a 5 percent profits interest only, how much income must she report, and what is her tax basis in the LLC interest?
c. If Connie receives a 5 percent capital and profits interest, how much income must she report, and what is her tax basis in the LLC interest?
- [LO2] Mary and Scott formed a partnership that maintains its records on a calendar-year basis. The balance sheet of the MS Partnership at year-end is as follows:
Basis Fair Market Value
Cash $ 60 $ 60
Land 60 180
Inventory 72 60
$192 $300
Mary $ 96 $150
Scott 96 150
$192 $300
At the end of the current year, Kari will receive aone-third capital interest only in exchange for services rendered. Kari’s interest will not be subject to a substantial risk of forfeiture and the costs for the type of services she provided are typically not capitalized by the partnership. For the current year, the income and expenses from operations are equal. Consequently, the only tax consequences for the year are those relating to the admission of Kari to the partnership.
a. Compute and characterize any gain or loss Kari may have to recognize as a result of her admission to the partnership.
b. Compute Kari’s basis in her partnership interest.
c. Prepare a balance sheet of the partnership immediately after Kari’s admission showing the partners’ tax capital accounts and capital accounts stated at fair market value.
d. Calculate how much gain or loss Kari would have to recognize if, instead of a capital interest, she only received a profits interest.
[LO2] Dave LaCroix recently received a 10 percent capital and profits interest in Cirque Capital LLC in exchange for consulting services he provided. If Cirque Capital had paid an outsider to provide the advice, it would have deducted the payment as compensation expense. Cirque Capital’s balance sheet on the day Dave received his capital interest appears below:
Assets: BasisFair Market Value
Cash $ 150,000 $ 150,000
Investments 200,000 700,000
Land 150,000 250,000
Totals $ 500,000 $1,100,000
Liabilities and capital:
Nonrecourse Debt 100,000 100,000
Lance* 200,000 500,000
Robert* 200,000 500,000
Totals $ 500,000 $ 1,100,000
*Assume that Lance’s basis and Robert’s basis in their LLC interests equal their tax basis capital accounts plus their respective shares of nonrecourse debt.
a. Compute and characterize any gain or loss Dave may have to recognize as a result of his admission to Cirque Capital.
b. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt of his interest.
c. Prepare a balance sheet for Cirque Capital immediately after Dave’s admission showing the members’ tax capital accounts and their capital accounts stated at fair market value.
d. Compute and characterize any gain or loss Dave may have to recognize as a result of his admission to Cirque Capital if he receives only a profits interest.
e. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt of his interest if Dave only receives a profits interest.
- [LO 2] Last December 31, Ramon sold the 10 percent interest in the Del Sol Partnership that he had held for two years to Garrett for $400,000. Prior to selling his interest, Ramon’s basis in Del Sol was $200,000 which included a $100,000 share of nonrecourse debt allocated to him.
a. What is Garrett’s tax basis in his partnership interest?
b. If Garrett sells his partnership interests three months after receiving it and recognizes a gain, what is the character of his gain?
- [LO 3] Broken Rock LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| George Allen | December 31 | 33.33% |
| Elanax Corp. | June 30 | 33.33% |
| Ray Kirk | December 31 | 33.34% |
What is the required taxable year-end for Broken Rock LLC?
- [LO 3] Granite Slab LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| Nelson Black | December 31 | 22.0% |
| Brittany Jones | December 31 | 24.0% |
| Lone Pine LLC | June 30 | 4.5% |
| Red Spot Inc. | October 31 | 4.5% |
| Pale Rock Inc. | September 30 | 4.5% |
| Thunder Ridge LLC | July 31 | 4.5% |
| Alpensee LLC | March 31 | 4.5% |
| Lakewood Inc. | June 30 | 4.5% |
| Streamside LLC | October 31 | 4.5% |
| Burnt Fork Inc. | October 31 | 4.5% |
| Snowy Ridge LP | June 30 | 4.5% |
| Whitewater LP | October 31 | 4.5% |
| Straw Hat LLC | January 31 | 4.5% |
| Wildfire Inc. | September 30 | 4.5% |
What is the required taxable year-end for Granite Slab LLC?
- [LO 3] Tall Tree LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| Eddie Robinson | December 31 | 40% |
| Pitcher Lenders LLC | June 30 | 25% |
| Perry Homes Inc. | October 31 | 35% |
What is the required taxable year-end for Tall Tree LLC?
.
- [LO 3] Rock Creek LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| Mark Banks | December 31 | 35% |
| Highball PropertiesLLC | March 31
|
25% |
| Chavez BuildersInc. | November 30 | 40% |
What is the required taxable year-end for Rock Creek LLC?
.
- [LO 3]{Research} Ryan, Dahir, and Bill have operated Broken Feather LLC for the last four years using a calendar year-end. Each has a one-third interest. Since they began operating, their busy season has run from June through August, with 35 percent of their gross receipts coming in July and August. The members would like to change their tax year-end and have asked you to address the following questions:
a. Can they change to an August 31 year-end and, if so, how do they make the change? {Hint: See Rev. Proc. 2002-38, 2002-1 CB 1037.}
b. Can they change to a September 30 year-end and, if so, how do they make the change?{Hint: See §444.}
- [LO 3] {Research}Ashlee, Hiroki, Kate, and Albee LLC each own a 25 percent interest in Tally Industries LLC, which generates annual gross receipts of over $10 million. Ashlee, Hiroki, and Kate manage the business, but Albee LLC is a nonmanaging member. Although Tally Industries has historically been profitable, for the last three years losses have been allocated to the members. Given these facts, the members want to know whether Tally Industries can use the cash method of accounting. Why or why not? {Hint: See § 448(b)(3)}
- [LO 4] Turtle Creek Partnership had the following revenues, expenses, gains, losses, and distributions:
Sales revenue $40,000
Long-term capital gains $2,000
Cost of goods sold ($13,000)
Depreciation – MACRS ($3,000)
Amortization of organization costs ($1,000)
Guaranteed payments to partners for general management ($10,000)
Cash distributions to partners ($2,000)
Given these items, what is Turtle Creek’s ordinary business income (loss) for the year?
- [LO 4] Georgio owns a 20 percent profits and capital interest in Rain Tree LLC. For the current year, Rain Tree had the following revenues, expenses, gains, and losses:
Sales revenue $70,000
Gain on sale of land (§1231) $11,000
Cost of goods sold ($26,000)
Depreciation – MACRS ($3,000)
§179 deduction* ($10,000)
Employee wages ($11,000)
Fines and penalties ($3,000)
Municipal bond interest $6,000
Short-term capital gains $4,000
Guaranteed payment to Sandra ($3,000)
*Assume the §179 property placed in service limitation does not apply.
a. How much ordinary business income (loss) is allocated to Georgio for the year?
b. What are Georgio’s separately stated items for the year?
[LO4] {Research} Richard Meyer and two friends from law school recently formed Meyer and Associates as a limited liability partnership (LLP). Income from the partnership will be split equally among the partners. The partnership will generate fee income primarily from representing clients in bankruptcy and foreclosure matters. While some attorney friends have suggested that the partners’ earnings will be self-employment income, other attorneys they know from their local bar association meetings claim just the opposite. After examining relevant authority, explain how you would advise Meyer and Associates on this matter. {Hint: See §1402(a)(13) and Renkemeyer, Campbell & Weaver LLP v.Commissioner, 136 T.C. 137 (2011)}
- [LO 4] The partnership agreement of the G&P general partnership states that Gary will receive a guaranteed payment of $13,000, and that Gary and Prudence will share the remaining profits or losses in a 45/55 ratio. For year 1, the G&P partnership reports the following results:
Sales revenue $70,000
Gain on sale of land (§ 1231) $8,000
Cost of goods sold ($38,000)
Depreciation – MACRS ($9,000)
Employee wages ($14,000)
Cash charitable contributions ($3,000)
Municipal bond interest $2,000
Other expenses ($2,000)
a. Compute Gary’s share of ordinary income (loss) and separately stated items to be reported on his year 1 Schedule K-1, including his self-employment income (loss).
b. Compute Gary’s share of self-employment income (loss) to be reported on his year 1 Schedule K-1, assuming G&P is a limited partnership and Gary is a limited partner.
c. What do you believe Gary’s share of self-employment income (loss) to be reported on his year 1 Schedule K-1 should be, assuming G&P is an LLC and Gary spends 2,000 hours per year working there full time?
- [LO 4] {Research} Hoki Poki, a cash-method general partnership, recorded the following items for its current tax year:
Rental real estate income $2,000
Sales revenue $70,000
§1245 recapture income $8,000
Interest income $2,000
Cost of goods sold ($38,000)
Depreciation – MACRS ($9,000)
Supplies expense ($1,000)
Employee wages ($14,000)
Investment interest expense ($1,000)
Partner’s medical insurance premiums paid by Hoki Poki ($3,000)
As part of preparing Hoki Poki’s current year return, identify the items that should be included in computing its ordinary business income (loss) and those that should be separately stated. {Hint: See Schedule K-1 and related preparer’s instructions at www.irs.gov.}
- [LO 4] {Research} On the last day of its current tax year, Buy Rite LLC received $300,000 when it sold a machine it had purchased for $200,000 three years ago to use in its business. At the time of the sale, the basis in the equipment had been reduced to $100,000 due to tax depreciation taken. How much did Buy Rite’s self-employment earnings increase when the equipment was sold? {Hint: See §1402(a)(3).}
[LO 4] Jhumpa, Stewart, and Kelly are all one-third partners in the capital and profits of Firewalker general partnership. In addition to their normal share of the partnership’s annual income, Jhumpa and Stewart receive an annual guaranteed payment of $10,000 to compensate them for additional services they provide. Firewalker’s income statement for the current year reflects the following revenues and expenses:
Sales revenue $340,000
Interest income 3,300
Long-term capital gains 1,200
Cost of goods sold (120,000)
Employee wages (75,000)
Depreciation expense (28,000)
Guaranteed payments (20,000)
Miscellaneous expenses (4,500)
Overall net income $97,000
a. Given Firewalker’s operating results, how much ordinary business income (loss) and what separately stated items [including the partners’ self-employment earnings (loss)] will it report on its return for the year?
b. How will it allocate these amounts to its partners?
c. How much self-employment tax will each partner pay assuming none have any other source of income or loss?
- [LO 4] {Research} Lane and Cal each own 50 percent of the profits and capital of HighYield LLC. HighYield owns a portfolio of taxable bonds and municipal bonds, and each year the portfolio generates approximately $10,000 of taxable interest and $10,000 of tax- exempt interest. Lane’s marginal tax rate is 35 percent while Cal’s marginal tax rate is 15 percent. To take advantage of the difference in their marginal tax rates, Lane and Cal want to modify their operating agreement to specially allocate all of the taxable interest to Cal and all of the tax-exempt interest to Lane. Until now, Lane and Cal had been allocated 50 percent of each type of interest income.
a. Is HighYield’s proposed special allocation acceptable under current tax rules? Why or why not? {Hint: See Reg. §1.704-1(b)(2)(iii)(b) and §1.704-1(b)(5) Example (5).}
b. If the IRS ultimately disagrees with HighYield’s special allocation, how will it likely reallocate the taxable and tax-exempt interest among the members? {Hint: See Reg. §1.704-1(b)(5) Example (5)(ii).}
- [LO 5] Larry’s tax basis in his partnership interest at the beginning of the year was $10,000. If his share of the partnership debt increased by $10,000 during the year and his share of partnership income for the year is $3,000, what is his tax basis in his partnership interest at the end of the year?
- [LO 5] Carmine was allocated the following items from the Piccolo LLC for last year:
Ordinary business loss
Nondeductible penalties
Tax-exempt interest income
Short-term capital gain
Cash distributions
Rank these items in terms of the order they should be applied to adjust Carmine’s tax basis in Piccolo for the year (some items may be of equal rank).
- [LO 5] Oscar, Felix, and Marv are all one-third partners in the capital and profits of Eastside general partnership. In addition to their normal share of the partnership’s annual income, Oscar and Felix receive annual guaranteed payments of $7,000 to compensate them for additional services they provide. Eastside’s income statement for the current year reflects the following revenues and expenses:
Sales revenue $ 420,000
Dividend income 5,700
Short-term capital gains 2,800
Cost of goods sold (210,000)
Employee wages (115,000)
Depreciation expense (28,000)
Guaranteed payments (14,000)
Miscellaneous expenses (9,500)
Overall net income$ 52,000
In addition, Eastside owed creditors $120,000 at the beginning of the year but managed to pay down its debts to $90,000 by the end of the year. All partnership debt is allocated equally among the partners. Finally, Oscar, Felix and Marv had a tax basis of $80,000 in their interests at the beginning of the year.
a. What tax basis do the partners have in their partnership interests at the end of the year?
a. Assume the partners began the year with a tax basis of $10,000 and all the debt was paid off on the last day of the year. How much gain will the partners recognize when the debt is paid off? What tax basis do the partners have in their partnership interests at the end of the year?
[LO 5] Pam, Sergei, and Mercedes are all one-third partners in the capital and profits of Oak Grove General Partnership. Partnership debt is allocated among the partners in accordance with their capital and profits interests. In addition to their normal share of the partnership’s annual income, Pam and Sergei receive annual guaranteed payments of $20,000 to compensate them for additional services they provide. Oak Grove’s income statement for the current year reflects the following revenues and expenses:
Sales revenue $476,700
Dividend income 6,600
§1231 losses (3,800)
Cost of goods sold (245,000)
Employee wages (92,000)
Depreciation expense (31,000)
Guaranteed payments (40,000)
Miscellaneous expenses (11,500)
Overall net income$ 60,000
In addition, Oak Grove owed creditors $90,000 at the beginning and $150,000 at the end of the year, and Pam, Sergei and Mercedes had a tax basis of $50,000 in their interests at the beginning of the year. Also, Sergei and Mercedes agreed to increase Pam’s capital and profits interest from 33.3 percent to 40 percent at the end of the tax year in exchange for additional services she provided to the partnership. The liquidation value of the additional capital interest Pam received at the end of the tax year is $40,000.
a. What tax basis do the partners have in their partnership interests at the end of the year?
b. If, in addition to the expenses listed above, the partnership donated $12,000 to a political campaign, what tax basis do the partners have in their partnership interests at the end of the year assuming the liquidation value of the additional capital interest Pam receives at the end of the year remains at $40,000?
66. [LO 6] {Research} Laura Davis is a member in a limited liability company that has historically been profitable but is expecting to generate losses in the near future because of a weak local economy. In addition to the hours she works as an employee of a local business, she currently spends approximately 150 hours per year helping to manage the LLC. Other LLC members each work approximately 175 hours per year in the LLC, and the time Laura and other members spend managing the LLC has remained constant since she joined the company three years ago. Laura’s tax basis and amount at-risk are large compared to her share of projected losses; however, she is concerned that her ability to deduct her share of the projected losses will be limited by the passive activity loss rules.
a. As an LLC member, will Laura’s share of losses be presumed to be passive as they are for limited partners? Why or why not? {Hint: See §469(h)(2) and Garnett v. Commissioner, 132 T.C. 368 (2009)}
b. Assuming Laura’s losses are not presumed to be passive, is she devoting sufficient time to the LLC to be considered a material participant? Why or why not?
c. What would you recommend to Laura to help her achieve a more favorable tax outcome?
- [LO 6] Alfonso began the year with a tax basis in his partnership interest of $30,000. His share of partnership debt at the beginning and end of the year consists of $4,000 of recourse debt and $6,000 of nonrecourse debt. During the year, he was allocated $40,000 of partnership ordinary business loss. Alfonso does not materially participate in this partnership and he has $1,000 of passive income from other sources.
a. How much of Alfonso’s loss is limited by his tax basis?
b. How much of Alfonso’s loss is limited by his at-risk amount?
a. How much of Alfonso’s loss is limited by the passive activity loss rules?
- [LO 5, 6] {Research} Juan Diego began the year with a tax basis in his partnership interest of $50,000. During the year, he was allocated $20,000 of partnership ordinary business income, $70,000 of §1231 losses, $30,000 of short-term capital losses, and received a cash distribution of $50,000.
a. What items related to these allocations does Juan Diego actually report on his tax return for the year? {Hint: See Reg. §1.704-1(d)(2) and Rev. Rul. 66-94.}
b. If any deductions or losses are limited, what are the carryover amounts and what is their character?{Hint: See Reg. §1.704-1(d).}
- [LO 6] Farell is a member of Sierra Vista LLC. Although Sierra Vista is involved in a number of different business ventures, it is not currently involved in real estate either as an investor or as a developer. On January 1, year 1, Farell has a $100,000 tax basis in his LLC interest that includes his $90,000 share of Sierra Vista’s general debt obligations. By the end of the year, Farell’s share of Sierra Vista’s general debt obligations has increased to $100,000. Because of the time he spends in other endeavors, Farell does not materially participate in Sierra Vista. His share of the Sierra Vista losses for year 1 is $120,000. As a partner in the Riverwoods Partnership, he also has year 1 Schedule K-1 passive income of $5,000.
a. Determine how much of the Sierra Vista loss Farell will currently be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
b. Assuming Farrell’s Riverwoods K-1 indicates passive income of $30,000, determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1 and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
a. Assuming Farrell is deemed to be an active participant in Sierra Vista, determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1 and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations
[LO 6] {Research} Jenkins has a one-third capital and profits interest in the Maverick General Partnership. On January 1, year 1, Maverick has $120,000 of general debt obligations and Jenkins has a $50,000 tax basis (including his share of Maverick’s debt) in his partnership interest. During the year, Maverick incurred a $30,000 nonrecourse debt that is not secured by real estate. Because Maverick is a rental real estate partnership, Jenkins is deemed to be a passive participant in Maverick. His share of the Maverick losses for year 1 is $75,000. Jenkins is not involved in any other passive activities and this is the first year he has been allocated losses from Maverick.
a. Determine how much of the Maverick loss Jenkins will currently be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
b. If Jenkins sells his interest on January 1, year 2, what happens to his suspended losses from year 1? {Hint: See Sennett v. Commissioner 80 TC 825 (1983) and Prop. Reg. §1.465-66(a).}
- [LO 6] {Planning} Suki and Steve own 50 percent capital and profits interests in Lorinda LLC. Lorinda operates the local minor league baseball team and owns the stadium where the team plays. Although the debt incurred to build the stadium was paid off several years ago, Lorinda owes its general creditors $300,000 (at the beginning and end of the year) that is not secured by firm property or guaranteed by any of the members. At the beginning of the current year Suki and Steve had a tax basis of $170,000 in their LLC interests including their share of debt owed to the general creditors. Shortly before the end of the year they each received a $10,000 cash distribution, even though Lorinda’s ordinary business loss for the year was $400,000. Because of the time commitment to operate a baseball team, both Suki and Steve spent more than 1,500 hours during the year operating Lorinda.
a. Determine how much of the Lorinda loss Suki and Steve will each be able to deduct on their current tax returns, and list their losses suspended by the tax basis, at-risk, and passive activity loss limitations.
b. Assume that sometime before receiving the $10,000 cash distribution, Steve is advised by his tax advisor that his marginal tax rate will be abnormally high during the current year because of an unexpected windfall. To help Steve utilize more of the losses allocated from Lorinda in the current year, his advisor recommends refusing the cash distribution and personally guaranteeing $100,000 of Lorinda’s debt, without the right to be reimbursed by Suki. If Steve follows his advisor’s recommendations, how much additional Lorinda loss can he deduct on his current tax return? How does Steve’s decision affect the amount of loss Suki can deduct on her current return and the amount and type of her suspended losses?
- [LO 6]{Research} Ray and Chuck own 50 percent capital and profits interests in Alpine Properties LLC. Alpine builds and manages rental real estate, and Ray and Chuck each work full time (over 1000 hours per year) managing Alpine. Alpine’s debt (both at the beginning and end of the year) consists of $1,500,000 in nonrecourse mortgages obtained from an unrelated bank and secured by various rental properties. At the beginning of the current year, Ray and Chuck each had a tax basis of $250,000 in his LLC interest including his share of the nonrecourse mortgage debt. Alpine’s ordinary business losses for the current year totaled $600,000 and neither member is involved in other activities that generate passive income.
a. How much of each member’s loss is suspended because of the tax basis limitation?
b. How much of each member’s loss is suspended because of the at-risk limitation?
c. How much of each member’s loss is suspended because of the passive activity loss limitation? {Hint: See §469(b)(7).}
Forming and Operating Partnerships
Solutions to Problems
- [LO 2] Joseph contributed $22,000 in cash and equipment with a tax basis of $5,000 and a fair market value of $11,000 to Berry Hill Partnership in exchange for a partnership interest.
a. What is Joseph’s tax basis in his partnership interest?
b. What is Berry Hill’s basis in the equipment?.
- [ LO 2] Lance contributed investment property worth $500,000, purchased three years ago for $200,000 cash, to Cloud Peak LLC in exchange for an 85 percent profits and capital interest in the LLC. Cloud Peak owes $300,000 to its suppliers but has no other debts.
a. What is Lance’s tax basis in his LLC interest?
b. What is Lance’s holding period in his interest?
c. What is Cloud Peak’s basis in the contributed property?
d. What is Cloud Peak’s holding period in the contributed property?
- [ LO 2] Laurel contributed equipment worth $200,000, purchased 10 months ago for $250,000 cash and used in her sole proprietorship, to Sand Creek LLC in exchange for a 15 percent profits and capital interest in the LLC. Laurel agreed to guarantee all $15,000 of Sand Creek’s accounts payable, but she did not guarantee any portion of the $100,000 nonrecourse mortgage securing Sand Creek’s office building. Other than the accounts payable and mortgage, Sand Creek does not owe any debts to other creditors.
a. What is Laurel’s initial tax basis in her LLC interest?
b. What is Laurel’s holding period in her interest?
c. What is Sand Creek’s initial basis in the contributed property?
d. What is Sand Creek’s holding period in the contributed property?
- [LO 2] {Planning}Harry and Sally formed the Evergreen partnership by contributing the following assets in exchange for a 50 percent capital and profits interest in the partnership:
Harry: BasisFair Market Value
Cash $ 30,000 $ 30,000
Land 100,000 120,000
Totals $ 130,000 $ 150,000
Sally:
Equipment used in a business 200,000 150,000
Totals $ 200,000 $ 150,000
a. How much gain or loss will Harry recognize on the contribution?
b. How much gain or loss will Sally recognize on the contribution?
c. How could the transaction be structured a different way to get a better result for Sally?
d. What is Harry’s tax basis in his partnership interest?
e. What is Sally’s tax basis in her partnership interest?
f. What is Evergreen’s tax basis in its assets?
g. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the Evergreen partnership showing the tax capital accounts for the partners.
- [LO 2] Cosmo contributed land with a fair market value of $400,000 and a tax basis of $90,000 to the Y Mountain partnership in exchange for a 25 percent profits and capital interest in the partnership. The land is secured by $120,000 of nonrecourse debt. Other than this nonrecourse debt, Y Mountain partnership does not have any debt.
a. How much gain will Cosmo recognize from the contribution?
b. What is Cosmo’s tax basis in his partnership interest?
- [LO2] When High Horizon LLC was formed, Maude contributed the following assets in exchange for a 25 percent capital and profits interest in the LLC:
Maude: BasisFair Market Value
Cash $ 20,000 $ 20,000
Land* 100,000 360,000
Totals $ 120,000 $ 380,000
*Nonrecourse debt secured by the land equals $160,000
James, Harold and Jenny each contributed $220,000 in cash for a 25% profits and capital interest.
a. How much gain or loss will Maude and the other members recognize?
b. What is Maude’s tax basis in her LLC interest?
c. What tax basis do James, Harold, and Jenny have in their LLC interests?
d. What is High Horizon’s tax basis in its assets?
e. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the High Horizon LLC showing the tax capital accounts for the members
- [LO2] Kevan, Jerry, and Dave formed Albee LLC. Jerry and Dave each contributed $245,000 in cash. Kevan contributed the following assets:
Kevan: BasisFair Market Value
Cash $ 15,000 $ 15,000
Land* 120,000 440,000
Totals $ 135,000 $ 455,000
*Nonrecourse debt secured by the land equals $210,000
Each member received a one-third capital and profits interest in the LLC.
a. How much gain or loss will Jerry, Dave and Kevan recognize on the contributions?
b. What is Kevan’s tax basis in his LLC interest?
c. What tax basis do Jerry and Dave have in their LLC interests?
d. What is Albee LLC’s tax basis in its assets?
e. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the Albee LLC showing the tax capital accounts for the members. What is Kevan’s share of the LLC’s inside basis?
f. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to guarantee 33.33 percent of the debt and Jerry to guarantee the remaining 66.67 percent of the debt when Albee LLC was formed, how much gain or loss will Kevan recognize?
a. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to guarantee 33.33 percent of the debt and Jerry to guarantee the remaining 66.67 percent of the debt when Albee LLC was formed, what are the members’ tax bases in their LLC interests?
- [LO2] {Research} Jim has decided to contribute some equipment he previously used in his sole proprietorship in exchange for a 10 percent profits and capital interest in Fast Choppers LLC. Jim originally paid $200,000 cash for the equipment. Since then, the tax basis in the equipment has been reduced to $100,000 because of tax depreciation, and the fair market value of the equipment is now $150,000.
a. Must Jim recognize any of the potential § 1245 recapture when he contributes the machinery to Fast Choppers? {Hint:See § 1245(b)(3).}
b. What cost recovery method will Fast Choppers use to depreciate the machinery? {Hint: See § 168(i)(7).}
c. If Fast Choppers were to immediately sell the equipment Jim contributed for $150,000, how much gain would Jim recognize and what is its character? {Hint: See § 1245 and 704(c).}
.
- [LO2] {Research} Ansel purchased raw land three years ago for $200,000 to hold as an investment. After watching the value of the land drop to $150,000, he decided to contribute it to Mountainside Developers LLC in exchange for a 5 percent capital and profits interest. Mountainside plans to develop the property and will treat it as inventory, like all of the other real estate it holds.
a. If Mountainside sells the property for $150,000 after holding it for one year, how much gain or loss does it recognize, and what is the character of its gain or loss? {Hint: See §724.}
b. If Mountainside sells the property for $125,000 after holding it for two years, how much gain or loss does it recognize, and what is the character of the gain or loss?
a. If Mountainside sells the property for $150,000 after holding it six years, how much gain or loss is recognized, and what is the character of the gain or loss?
b.
- [LO2] {Research} Claude purchased raw land three years ago for $1,500,000 to develop into lots and sell to individuals planning to build their dream homes. Claude intended to treat this property as inventory, like his other development properties. Before completing the development of the property, however, he decided to contribute it to South Peak Investors LLC when it was worth $2,500,000, in exchange for a 10 percent capital and profits interest. South Peak’s strategy is to hold land for investment purposes only and then sell it later at a gain.
a. If South Peak sells the property for $3,000,000 four years after Claude’s contribution, how much gain or loss is recognized and what is its character? {Hint:See § 724.}
b. If South Peak sells the property for $3,000,000 five and one-half years after Claude’s contribution, how much gain or loss is recognized and what is its character?
- [LO2] {Research} Reggie contributed $10,000 in cash and a capital asset he had held for three years with a fair market value of $20,000 and tax basis of $10,000 for a 5 percent capital and profits interest in Green Valley LLC.
a. If Reggie sells his LLC interest thirteen months later for $30,000 when the tax basis in his partnership interest is still $20,000, how much gain does he report and what is its character?
b. If Reggie sells his LLC interest two months later for $30,000 when the tax basis in his partnership interest is still $20,000, how much gain does he report and what is its character? {Hint: See Reg. §1.1223-3}
- [LO2] Connie recently provided legal services to the Winterhaven LLC and received a 5 percent interest in the LLC as compensation. Winterhaven currently has $50,000 of accounts payable and no other debt. The current fair market value of Winterhaven’s capital is $200,000.
a. If Connie receives a 5 percent capital interest only, how much income must she report, and what is her tax basis in the LLC interest?
b. If Connie receives a 5 percent profits interest only, how much income must she report, and what is her tax basis in the LLC interest?
c. If Connie receives a 5 percent capital and profits interest, how much income must she report, and what is her tax basis in the LLC interest?
- [LO2] Mary and Scott formed a partnership that maintains its records on a calendar-year basis. The balance sheet of the MS Partnership at year-end is as follows:
Basis Fair Market Value
Cash $ 60 $ 60
Land 60 180
Inventory 72 60
$192 $300
Mary $ 96 $150
Scott 96 150
$192 $300
At the end of the current year, Kari will receive aone-third capital interest only in exchange for services rendered. Kari’s interest will not be subject to a substantial risk of forfeiture and the costs for the type of services she provided are typically not capitalized by the partnership. For the current year, the income and expenses from operations are equal. Consequently, the only tax consequences for the year are those relating to the admission of Kari to the partnership.
a. Compute and characterize any gain or loss Kari may have to recognize as a result of her admission to the partnership.
b. Compute Kari’s basis in her partnership interest.
c. Prepare a balance sheet of the partnership immediately after Kari’s admission showing the partners’ tax capital accounts and capital accounts stated at fair market value.
d. Calculate how much gain or loss Kari would have to recognize if, instead of a capital interest, she only received a profits interest.
[LO2] Dave LaCroix recently received a 10 percent capital and profits interest in Cirque Capital LLC in exchange for consulting services he provided. If Cirque Capital had paid an outsider to provide the advice, it would have deducted the payment as compensation expense. Cirque Capital’s balance sheet on the day Dave received his capital interest appears below:
Assets: BasisFair Market Value
Cash $ 150,000 $ 150,000
Investments 200,000 700,000
Land 150,000 250,000
Totals $ 500,000 $1,100,000
Liabilities and capital:
Nonrecourse Debt 100,000 100,000
Lance* 200,000 500,000
Robert* 200,000 500,000
Totals $ 500,000 $ 1,100,000
*Assume that Lance’s basis and Robert’s basis in their LLC interests equal their tax basis capital accounts plus their respective shares of nonrecourse debt.
a. Compute and characterize any gain or loss Dave may have to recognize as a result of his admission to Cirque Capital.
b. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt of his interest.
c. Prepare a balance sheet for Cirque Capital immediately after Dave’s admission showing the members’ tax capital accounts and their capital accounts stated at fair market value.
d. Compute and characterize any gain or loss Dave may have to recognize as a result of his admission to Cirque Capital if he receives only a profits interest.
e. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt of his interest if Dave only receives a profits interest.
- [LO 2] Last December 31, Ramon sold the 10 percent interest in the Del Sol Partnership that he had held for two years to Garrett for $400,000. Prior to selling his interest, Ramon’s basis in Del Sol was $200,000 which included a $100,000 share of nonrecourse debt allocated to him.
a. What is Garrett’s tax basis in his partnership interest?
b. If Garrett sells his partnership interests three months after receiving it and recognizes a gain, what is the character of his gain?
- [LO 3] Broken Rock LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| George Allen | December 31 | 33.33% |
| Elanax Corp. | June 30 | 33.33% |
| Ray Kirk | December 31 | 33.34% |
What is the required taxable year-end for Broken Rock LLC?
- [LO 3] Granite Slab LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| Nelson Black | December 31 | 22.0% |
| Brittany Jones | December 31 | 24.0% |
| Lone Pine LLC | June 30 | 4.5% |
| Red Spot Inc. | October 31 | 4.5% |
| Pale Rock Inc. | September 30 | 4.5% |
| Thunder Ridge LLC | July 31 | 4.5% |
| Alpensee LLC | March 31 | 4.5% |
| Lakewood Inc. | June 30 | 4.5% |
| Streamside LLC | October 31 | 4.5% |
| Burnt Fork Inc. | October 31 | 4.5% |
| Snowy Ridge LP | June 30 | 4.5% |
| Whitewater LP | October 31 | 4.5% |
| Straw Hat LLC | January 31 | 4.5% |
| Wildfire Inc. | September 30 | 4.5% |
What is the required taxable year-end for Granite Slab LLC?
- [LO 3] Tall Tree LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| Eddie Robinson | December 31 | 40% |
| Pitcher Lenders LLC | June 30 | 25% |
| Perry Homes Inc. | October 31 | 35% |
What is the required taxable year-end for Tall Tree LLC?
.
- [LO 3] Rock Creek LLC was recently formed with the following members:
| Name | Tax Year End | Capital/Profits % |
| Mark Banks | December 31 | 35% |
| Highball PropertiesLLC | March 31
|
25% |
| Chavez BuildersInc. | November 30 | 40% |
What is the required taxable year-end for Rock Creek LLC?
.
- [LO 3]{Research} Ryan, Dahir, and Bill have operated Broken Feather LLC for the last four years using a calendar year-end. Each has a one-third interest. Since they began operating, their busy season has run from June through August, with 35 percent of their gross receipts coming in July and August. The members would like to change their tax year-end and have asked you to address the following questions:
a. Can they change to an August 31 year-end and, if so, how do they make the change? {Hint: See Rev. Proc. 2002-38, 2002-1 CB 1037.}
b. Can they change to a September 30 year-end and, if so, how do they make the change?{Hint: See §444.}
- [LO 3] {Research}Ashlee, Hiroki, Kate, and Albee LLC each own a 25 percent interest in Tally Industries LLC, which generates annual gross receipts of over $10 million. Ashlee, Hiroki, and Kate manage the business, but Albee LLC is a nonmanaging member. Although Tally Industries has historically been profitable, for the last three years losses have been allocated to the members. Given these facts, the members want to know whether Tally Industries can use the cash method of accounting. Why or why not? {Hint: See § 448(b)(3)}
- [LO 4] Turtle Creek Partnership had the following revenues, expenses, gains, losses, and distributions:
Sales revenue $40,000
Long-term capital gains $2,000
Cost of goods sold ($13,000)
Depreciation – MACRS ($3,000)
Amortization of organization costs ($1,000)
Guaranteed payments to partners for general management ($10,000)
Cash distributions to partners ($2,000)
Given these items, what is Turtle Creek’s ordinary business income (loss) for the year?
- [LO 4] Georgio owns a 20 percent profits and capital interest in Rain Tree LLC. For the current year, Rain Tree had the following revenues, expenses, gains, and losses:
Sales revenue $70,000
Gain on sale of land (§1231) $11,000
Cost of goods sold ($26,000)
Depreciation – MACRS ($3,000)
§179 deduction* ($10,000)
Employee wages ($11,000)
Fines and penalties ($3,000)
Municipal bond interest $6,000
Short-term capital gains $4,000
Guaranteed payment to Sandra ($3,000)
*Assume the §179 property placed in service limitation does not apply.
a. How much ordinary business income (loss) is allocated to Georgio for the year?
b. What are Georgio’s separately stated items for the year?
[LO4] {Research} Richard Meyer and two friends from law school recently formed Meyer and Associates as a limited liability partnership (LLP). Income from the partnership will be split equally among the partners. The partnership will generate fee income primarily from representing clients in bankruptcy and foreclosure matters. While some attorney friends have suggested that the partners’ earnings will be self-employment income, other attorneys they know from their local bar association meetings claim just the opposite. After examining relevant authority, explain how you would advise Meyer and Associates on this matter. {Hint: See §1402(a)(13) and Renkemeyer, Campbell & Weaver LLP v.Commissioner, 136 T.C. 137 (2011)}
- [LO 4] The partnership agreement of the G&P general partnership states that Gary will receive a guaranteed payment of $13,000, and that Gary and Prudence will share the remaining profits or losses in a 45/55 ratio. For year 1, the G&P partnership reports the following results:
Sales revenue $70,000
Gain on sale of land (§ 1231) $8,000
Cost of goods sold ($38,000)
Depreciation – MACRS ($9,000)
Employee wages ($14,000)
Cash charitable contributions ($3,000)
Municipal bond interest $2,000
Other expenses ($2,000)
a. Compute Gary’s share of ordinary income (loss) and separately stated items to be reported on his year 1 Schedule K-1, including his self-employment income (loss).
b. Compute Gary’s share of self-employment income (loss) to be reported on his year 1 Schedule K-1, assuming G&P is a limited partnership and Gary is a limited partner.
c. What do you believe Gary’s share of self-employment income (loss) to be reported on his year 1 Schedule K-1 should be, assuming G&P is an LLC and Gary spends 2,000 hours per year working there full time?
- [LO 4] {Research} Hoki Poki, a cash-method general partnership, recorded the following items for its current tax year:
Rental real estate income $2,000
Sales revenue $70,000
§1245 recapture income $8,000
Interest income $2,000
Cost of goods sold ($38,000)
Depreciation – MACRS ($9,000)
Supplies expense ($1,000)
Employee wages ($14,000)
Investment interest expense ($1,000)
Partner’s medical insurance premiums paid by Hoki Poki ($3,000)
As part of preparing Hoki Poki’s current year return, identify the items that should be included in computing its ordinary business income (loss) and those that should be separately stated. {Hint: See Schedule K-1 and related preparer’s instructions at www.irs.gov.}
- [LO 4] {Research} On the last day of its current tax year, Buy Rite LLC received $300,000 when it sold a machine it had purchased for $200,000 three years ago to use in its business. At the time of the sale, the basis in the equipment had been reduced to $100,000 due to tax depreciation taken. How much did Buy Rite’s self-employment earnings increase when the equipment was sold? {Hint: See §1402(a)(3).}
[LO 4] Jhumpa, Stewart, and Kelly are all one-third partners in the capital and profits of Firewalker general partnership. In addition to their normal share of the partnership’s annual income, Jhumpa and Stewart receive an annual guaranteed payment of $10,000 to compensate them for additional services they provide. Firewalker’s income statement for the current year reflects the following revenues and expenses:
Sales revenue $340,000
Interest income 3,300
Long-term capital gains 1,200
Cost of goods sold (120,000)
Employee wages (75,000)
Depreciation expense (28,000)
Guaranteed payments (20,000)
Miscellaneous expenses (4,500)
Overall net income $97,000
a. Given Firewalker’s operating results, how much ordinary business income (loss) and what separately stated items [including the partners’ self-employment earnings (loss)] will it report on its return for the year?
b. How will it allocate these amounts to its partners?
c. How much self-employment tax will each partner pay assuming none have any other source of income or loss?
- [LO 4] {Research} Lane and Cal each own 50 percent of the profits and capital of HighYield LLC. HighYield owns a portfolio of taxable bonds and municipal bonds, and each year the portfolio generates approximately $10,000 of taxable interest and $10,000 of tax- exempt interest. Lane’s marginal tax rate is 35 percent while Cal’s marginal tax rate is 15 percent. To take advantage of the difference in their marginal tax rates, Lane and Cal want to modify their operating agreement to specially allocate all of the taxable interest to Cal and all of the tax-exempt interest to Lane. Until now, Lane and Cal had been allocated 50 percent of each type of interest income.
a. Is HighYield’s proposed special allocation acceptable under current tax rules? Why or why not? {Hint: See Reg. §1.704-1(b)(2)(iii)(b) and §1.704-1(b)(5) Example (5).}
b. If the IRS ultimately disagrees with HighYield’s special allocation, how will it likely reallocate the taxable and tax-exempt interest among the members? {Hint: See Reg. §1.704-1(b)(5) Example (5)(ii).}
- [LO 5] Larry’s tax basis in his partnership interest at the beginning of the year was $10,000. If his share of the partnership debt increased by $10,000 during the year and his share of partnership income for the year is $3,000, what is his tax basis in his partnership interest at the end of the year?
- [LO 5] Carmine was allocated the following items from the Piccolo LLC for last year:
Ordinary business loss
Nondeductible penalties
Tax-exempt interest income
Short-term capital gain
Cash distributions
Rank these items in terms of the order they should be applied to adjust Carmine’s tax basis in Piccolo for the year (some items may be of equal rank).
- [LO 5] Oscar, Felix, and Marv are all one-third partners in the capital and profits of Eastside general partnership. In addition to their normal share of the partnership’s annual income, Oscar and Felix receive annual guaranteed payments of $7,000 to compensate them for additional services they provide. Eastside’s income statement for the current year reflects the following revenues and expenses:
Sales revenue $ 420,000
Dividend income 5,700
Short-term capital gains 2,800
Cost of goods sold (210,000)
Employee wages (115,000)
Depreciation expense (28,000)
Guaranteed payments (14,000)
Miscellaneous expenses (9,500)
Overall net income$ 52,000
In addition, Eastside owed creditors $120,000 at the beginning of the year but managed to pay down its debts to $90,000 by the end of the year. All partnership debt is allocated equally among the partners. Finally, Oscar, Felix and Marv had a tax basis of $80,000 in their interests at the beginning of the year.
a. What tax basis do the partners have in their partnership interests at the end of the year?
a. Assume the partners began the year with a tax basis of $10,000 and all the debt was paid off on the last day of the year. How much gain will the partners recognize when the debt is paid off? What tax basis do the partners have in their partnership interests at the end of the year?
[LO 5] Pam, Sergei, and Mercedes are all one-third partners in the capital and profits of Oak Grove General Partnership. Partnership debt is allocated among the partners in accordance with their capital and profits interests. In addition to their normal share of the partnership’s annual income, Pam and Sergei receive annual guaranteed payments of $20,000 to compensate them for additional services they provide. Oak Grove’s income statement for the current year reflects the following revenues and expenses:
Sales revenue $476,700
Dividend income 6,600
§1231 losses (3,800)
Cost of goods sold (245,000)
Employee wages (92,000)
Depreciation expense (31,000)
Guaranteed payments (40,000)
Miscellaneous expenses (11,500)
Overall net income$ 60,000
In addition, Oak Grove owed creditors $90,000 at the beginning and $150,000 at the end of the year, and Pam, Sergei and Mercedes had a tax basis of $50,000 in their interests at the beginning of the year. Also, Sergei and Mercedes agreed to increase Pam’s capital and profits interest from 33.3 percent to 40 percent at the end of the tax year in exchange for additional services she provided to the partnership. The liquidation value of the additional capital interest Pam received at the end of the tax year is $40,000.
a. What tax basis do the partners have in their partnership interests at the end of the year?
b. If, in addition to the expenses listed above, the partnership donated $12,000 to a political campaign, what tax basis do the partners have in their partnership interests at the end of the year assuming the liquidation value of the additional capital interest Pam receives at the end of the year remains at $40,000?
66. [LO 6] {Research} Laura Davis is a member in a limited liability company that has historically been profitable but is expecting to generate losses in the near future because of a weak local economy. In addition to the hours she works as an employee of a local business, she currently spends approximately 150 hours per year helping to manage the LLC. Other LLC members each work approximately 175 hours per year in the LLC, and the time Laura and other members spend managing the LLC has remained constant since she joined the company three years ago. Laura’s tax basis and amount at-risk are large compared to her share of projected losses; however, she is concerned that her ability to deduct her share of the projected losses will be limited by the passive activity loss rules.
a. As an LLC member, will Laura’s share of losses be presumed to be passive as they are for limited partners? Why or why not? {Hint: See §469(h)(2) and Garnett v. Commissioner, 132 T.C. 368 (2009)}
b. Assuming Laura’s losses are not presumed to be passive, is she devoting sufficient time to the LLC to be considered a material participant? Why or why not?
c. What would you recommend to Laura to help her achieve a more favorable tax outcome?
- [LO 6] Alfonso began the year with a tax basis in his partnership interest of $30,000. His share of partnership debt at the beginning and end of the year consists of $4,000 of recourse debt and $6,000 of nonrecourse debt. During the year, he was allocated $40,000 of partnership ordinary business loss. Alfonso does not materially participate in this partnership and he has $1,000 of passive income from other sources.
a. How much of Alfonso’s loss is limited by his tax basis?
b. How much of Alfonso’s loss is limited by his at-risk amount?
a. How much of Alfonso’s loss is limited by the passive activity loss rules?
- [LO 5, 6] {Research} Juan Diego began the year with a tax basis in his partnership interest of $50,000. During the year, he was allocated $20,000 of partnership ordinary business income, $70,000 of §1231 losses, $30,000 of short-term capital losses, and received a cash distribution of $50,000.
a. What items related to these allocations does Juan Diego actually report on his tax return for the year? {Hint: See Reg. §1.704-1(d)(2) and Rev. Rul. 66-94.}
b. If any deductions or losses are limited, what are the carryover amounts and what is their character?{Hint: See Reg. §1.704-1(d).}
- [LO 6] Farell is a member of Sierra Vista LLC. Although Sierra Vista is involved in a number of different business ventures, it is not currently involved in real estate either as an investor or as a developer. On January 1, year 1, Farell has a $100,000 tax basis in his LLC interest that includes his $90,000 share of Sierra Vista’s general debt obligations. By the end of the year, Farell’s share of Sierra Vista’s general debt obligations has increased to $100,000. Because of the time he spends in other endeavors, Farell does not materially participate in Sierra Vista. His share of the Sierra Vista losses for year 1 is $120,000. As a partner in the Riverwoods Partnership, he also has year 1 Schedule K-1 passive income of $5,000.
a. Determine how much of the Sierra Vista loss Farell will currently be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
b. Assuming Farrell’s Riverwoods K-1 indicates passive income of $30,000, determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1 and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
a. Assuming Farrell is deemed to be an active participant in Sierra Vista, determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1 and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations
[LO 6] {Research} Jenkins has a one-third capital and profits interest in the Maverick General Partnership. On January 1, year 1, Maverick has $120,000 of general debt obligations and Jenkins has a $50,000 tax basis (including his share of Maverick’s debt) in his partnership interest. During the year, Maverick incurred a $30,000 nonrecourse debt that is not secured by real estate. Because Maverick is a rental real estate partnership, Jenkins is deemed to be a passive participant in Maverick. His share of the Maverick losses for year 1 is $75,000. Jenkins is not involved in any other passive activities and this is the first year he has been allocated losses from Maverick.
a. Determine how much of the Maverick loss Jenkins will currently be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
b. If Jenkins sells his interest on January 1, year 2, what happens to his suspended losses from year 1? {Hint: See Sennett v. Commissioner 80 TC 825 (1983) and Prop. Reg. §1.465-66(a).}
- [LO 6] {Planning} Suki and Steve own 50 percent capital and profits interests in Lorinda LLC. Lorinda operates the local minor league baseball team and owns the stadium where the team plays. Although the debt incurred to build the stadium was paid off several years ago, Lorinda owes its general creditors $300,000 (at the beginning and end of the year) that is not secured by firm property or guaranteed by any of the members. At the beginning of the current year Suki and Steve had a tax basis of $170,000 in their LLC interests including their share of debt owed to the general creditors. Shortly before the end of the year they each received a $10,000 cash distribution, even though Lorinda’s ordinary business loss for the year was $400,000. Because of the time commitment to operate a baseball team, both Suki and Steve spent more than 1,500 hours during the year operating Lorinda.
a. Determine how much of the Lorinda loss Suki and Steve will each be able to deduct on their current tax returns, and list their losses suspended by the tax basis, at-risk, and passive activity loss limitations.
b. Assume that sometime before receiving the $10,000 cash distribution, Steve is advised by his tax advisor that his marginal tax rate will be abnormally high during the current year because of an unexpected windfall. To help Steve utilize more of the losses allocated from Lorinda in the current year, his advisor recommends refusing the cash distribution and personally guaranteeing $100,000 of Lorinda’s debt, without the right to be reimbursed by Suki. If Steve follows his advisor’s recommendations, how much additional Lorinda loss can he deduct on his current tax return? How does Steve’s decision affect the amount of loss Suki can deduct on her current return and the amount and type of her suspended losses?
- [LO 6]{Research} Ray and Chuck own 50 percent capital and profits interests in Alpine Properties LLC. Alpine builds and manages rental real estate, and Ray and Chuck each work full time (over 1000 hours per year) managing Alpine. Alpine’s debt (both at the beginning and end of the year) consists of $1,500,000 in nonrecourse mortgages obtained from an unrelated bank and secured by various rental properties. At the beginning of the current year, Ray and Chuck each had a tax basis of $250,000 in his LLC interest including his share of the nonrecourse mortgage debt. Alpine’s ordinary business losses for the current year totaled $600,000 and neither member is involved in other activities that generate passive income.
a. How much of each member’s loss is suspended because of the tax basis limitation?
b. How much of each member’s loss is suspended because of the at-risk limitation?
c. How much of each member’s loss is suspended because of the passive activity loss limitation? {Hint: See §469(b)(7).}
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