Professional Documents
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Chapter 19
Chapter 19 Exhibits
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. PartnershipsOverview PartnershipsTypes of Partnerships PartnershipsTax Years PartnershipsAccounting Methods PartnershipsTax Formula Code Section 702(a)(8) Income or Loss Separately Stated Items Formation of PartnershipsPartner Perspective Formation of PartnershipsOverview of Code Section 721 Contribution of Part Property/Part Services Contribution of Part Property/Part ServicesExample Disguised SalesGeneral Rules Disguised SalesExample
CCH Federal Taxation Comprehensive Topics 2 of 67
Chapter 19 Exhibits
14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. Contribution of Encumbered Property Contribution of Encumbered PropertyExample Contribution of Know-How Contribution of Know-HowExample Inside Basis Computations Outside Basis Computations Outside Basis ComputationsExample Code Section 465 At-Risk Rules Code Section 469 Passive Activity Loss (PAL) Rules At-Risk and Passive Activity Loss RulesExample Partners Providing Infrequent, Nonessential Services to Partnerships for Compensation 25. Partners Providing Ongoing, Integral Services to Partnerships for Compensation
Chapter 19, Exhibit Contents B CCH Federal Taxation Comprehensive Topics 3 of 67
PartnershipsOverview
Definition Of Partnership. An unincorporated association with two or more persons who associate for a profit motive. For income tax purposes, partnerships are generally treated as passthrough entities, i.e., the partnership pays no taxes, and partnership income (loss) and separately stated items are allocated to each partner according to the partnerships profit sharing agreement. The partners receive separate K-1 schedules from the partnership. Each K-1 reports each partners share of the partnership net profit and separately reported income and expense items. Partners report these items on their own 1040 tax returns, even if none of the items have been distributed to them.
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PartnershipsTypes of Partnerships
General Partnership [GP]. A GP has one or more general partners who is personally liable for partnership debts; a general partner can be bankrupted by a malpractice judgment brought against the partnership, even though the partner was not personally involved in the malpractice. Limited Liability Partnership [LLP]. An LLP is similar to a general partnership, except that an LLP partner is not liable for any malpractice committed by the other LLP partners. Limited Partnership [LP]. An LP is comprised of at least one general partner and often many limited partners. Limited partners may not participate in the management of the LP, and their risks of loss are restricted to their equity investments in the LP.
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PartnershipsTypes of Partnerships
Limited Liability Company [LLC]. An LLC is a state-registered association generally taxed as a partnership if it checks the box. LLC members, like corporate shareholders are not personally liable. Unlike limited partners, LLC members may participate in management without risking personal liability. However, guaranteed payments are subject to self-employment tax, along with the members share of ordinary income or loss from the LLC.
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PartnershipsTax Years
The following rules govern tax years of partnerships: Majority Interest Taxable Year. Partnerships are generally required to elect the same taxable year as their partners who represent a majority interest on the first day of the partnerships first tax year. Code Sec. 706(b). Five Percenters Common Tax Year. If there is no majority interest taxable year, the partnership must use the same year as that of the principal partners, i.e., those owning five percent or more interest in either profits or capital.
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PartnershipsTax Years
Calendar Tax Year. If there is no majority interest tax year and the principal partners do not have the same taxable year, the partnership generally must use the calendar year. There are two exceptions, (1) minimum deferral rules and (2) business purpose rules. Details regarding these exceptions are covered in the text.
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PartnershipsAccounting Methods
Cash method. The cash method is available to partnerships that do not have a C corporation partner. The cash method however, MAY be used by partnerships with C corporation partners if the partnerships average annual gross receipts are $5 million or less in the 3 preceding years. The determination is made annually. Accrual Method. Once the three-year average annual gross receipts exceeds $5 million, a partnership with a C corporation partner must use the accrual basis thereafter.
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Tax Formula
[Taxation at Owner Level] Ordinary Income From Whatever Source Derived (including Code Sec. 1245 recapture) = Exclusions and Cost of Goods Sold Gross Income from Business Operations Operating Expenses Code Sec. 702(a)(8) Ordinary Income
+ or - Separately Stated Items (These are items that may result in different tax treatment by different partners. Examples include capital gain or loss and charitable contributions.)
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Disguised SalesExample
FACTS: Fred transfers land [$400 fair market value (FMV), $120 adjusted basis (AB), held long-term for investment purposes] to a partnership (P/S) in exchange for: 1. A capital interest worth $100; 2. $300 cash. QUESTIONS: A. What portion of the exchange represents a disguised sale? B. What portion of the exchange represents a Code Sec. 721 contribution? C. What is the tax treatment to Fred? D. What is the tax treatment to P/S?
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Disguised SalesExample
SOLUTION The transfer is treated as a partial disguised sale and a partial partnership contribution Total FMV of cap. int. Cash Amount realized Basis in land Realized gain Recognized gain Character of gain 100 300 400 120 280 Disguised Sale (75%): 75 225 300 90 [75%] 210 210 LTCG Contribution (25%): 25 75 100 30 [25%] 70 0 Not recognized
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Disguised SalesExample
SOLUTION The transfer is treated as a partial disguised sale and a partial partnership contribution: Total Computation Reason for tax treatment Disguised Sale (75%): 100% - 25% = 75% Contribution (25%): (400-300) 400) = 25%
Reg. 1.707-3(a) Recognition Code Sec. 721 of realized gain from Non-recognition on transfer of disguised sale. property for a P/S interest.
Freds basis in the partnership interest: $30 [25% of the basis of land is attributable to a contribution. P/S basis in the land: $330 [Freds 30 basis of land contributed + 300 sale price.]
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Disguised SalesExample
COMMENTS Even if Fred had received the $300 cash 2 years after receipt of a P/S interest, IRS would still presume that Freds contribution was partially a disguised sale as per above. Fred would have to prove otherwise.
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0 (since no XS debt 16,000 relief) 0 (since Code Sec. 12,000 721 nonrecog applies.)
Basis of the land to the P/S: $20,000. (Bobs AB of $20m + $0 gain recognized by Bob)
Chapter 19, Exhibit 15d CCH Federal Taxation Comprehensive Topics 38 of 67
$30,000 Code Sec. 83(a) (Services contd are OI to extent of FMV of P/S interest.)
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(f) = P/S debt Less: Share of debt assumption x 1/3 assumption (g) = (e) (f) (h) = (b) (i) = (g) (h) (j) = (i) Net debt relief Basis in asset contributed Excess debt relief Capital gain recognized on excess debt relief
30,000 $30,000 Code Sec.732 P/S basis in assets is same as Ps before contribution + any Code Sec. 83(a) gain
Contribution of Know-How
What is the tax effect on a partner who acquires a P/S interest without contributing property or services? A person may be valued by a partnership (P/S) for her client contacts, or unique ability to do certain things (know-how). If admitted into the P/S without contributing property or services, the P/S credits the partners capital account, based on her % share of the fair market value (FMV) of P/S assets, net of her % share of P/S debt. The offset is to goodwill, which is treated as property in a Code Sec. 721 exchange (i.e., non-recognition treatment when contributed to the P/S in exchange for an outside interest).
Chapter 19, Exhibit 16 CCH Federal Taxation Comprehensive Topics 44 of 67
Contribution of Know-HowExample
FACTS: Jack and Jill form a P/S by contributing the property listed below. QUESTION: What are the tax consequences to Jack, Jill and the P/S? Jack Jill Property Contributed Agreed upon FMV Basis Realizable gain on contribn Recognized gain on contribn Ps outside basis in P/S int. Built-in gains P/S inside basis in the assets Capital balance of each partner
Chapter 19, Exhibit 17a
Land $15,000 5,000 $10,000 0 (Code Sec. 721) $ 5,000 10,000 $ 5,000 $15,000 (10 + 5)
0 0
15,000
Contribution of Know-HowExample
SOLUTION: If both Jack and Jill were to sell their partnership interests for $15,000 each, assuming no other transactions, the partnership would have no distributive gain, [since postcontribution-date values do not change] but Jack and Jill would recognize their respective built-in gains: Jack: $10,000 capital gain [$15,000 FMV at contribution $5,000 basis at contribution] Jill: $15m capital gain [$15,00 FMV at contribution $0 basis at contribution].
Chapter 19, Exhibit 17b CCH Federal Taxation Comprehensive Topics 46 of 67
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[Note that an outside basis can have a split holding period if multiple assets are contributed.]
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$25,000 $24,000 =[1/2 x $48,000] $5,275 =[1/2 x (5+6.2+.5-.1-.25-.8)] $ (3,000) =[1/2 x ($30,000 - $24,000)] $(10,000) = [100% x $10,000] $41,275 $29,275 =[$41,275 - (1/2 x $24,000 debt]
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x1
24
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(b) = 0 3
0 (g) = 0 (3)
x2
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