Chapter 9 Flashcards
(115 cards)
1
Q
Formation of a partnership requires legal documentation filed with the Secretary of State.
A
False
2
Q
Identify which of the following statements is true.
A) Formation of a partnership requires legal documentation.
B) An individual engaged in the active conduct of a business must elect not to be taxed as a partnership.
C) A partnership exists as long as there are at least two individuals or entities engaged in the active conduct of a trade or business or a financial operation, and the business is not a trust or a corporation.
D) All of the above are false.
A
C) A partnership exists as long as there are at least two individuals or entities engaged in the active conduct of a trade or business or a financial operation, and the business is not a trust or a corporation.
3
Q
The definition of a partnership does not include A) a syndicate. B) a group. C) a pool. D) All of the above are included.
A
D) All of the above are included.
4
Q
Identify which of the following statements is true.
A) All of the partners in a limited partnership have limited liability.
B) A limited partnership must have at least two general partners.
C) A limited partnership cannot have a corporate general partner.
D) All of the above are false.
A
D) All of the above are false.
5
Q
Which of the following is false?
A) A large partnership must not be a service partnership.
B) A large partnership must have fewer than 100 partners.
C) A large partnership must not be engaged in commodity trading.
D) A large partnership is subject to a different system of audits.
A
B) A large partnership must have fewer than 100 partners.
6
Q
Electing large partnership rules differ from other partnership rules in all of the following areas except
A) partnership income reporting.
B) partnership termination.
C) partnership audits.
D) All of the above are large partnership rule differences.
A
D) All of the above are large partnership rule differences.
7
Q
A partner’s basis for his partnership interest can be negative.
A
False
8
Q
On the first day of the partnership's tax year, Karen purchases a 50% interest in a general partnership for $30,000 cash and she materially participates in the operation of the partnership for the entire year. The partnership has $40,000 in recourse liabilities when Karen enters the partnership. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. There is no minimum gain related to the nonrecourse liability. During the year, the partnership incurs a $120,000 loss and a $20,000 increase in liabilities. How much of the loss can Karen report on her tax return for the current year? A) $30,000 B) $40,000 C) $50,000 D) $60,000
A
D) $60,000
Beginning basis $30,000 Plus: 50% of beginning-of-year liabilities 20,000 Plus: 50% of increase in liabilities 10,000 Karen's Sec. 704(d) basis $60,000 Karen's at-risk basis $60,000 50% of partnership loss ($120,000 × 0.50) $60,000
The loss is deductible only to the extent of Karen’s at-risk basis, or $50,000.
9
Q
Identify which of the following statements is true.
A) Distribution of partnership income in the form of cash to partners is generally tax-free to the partners and the partnership.
B) When partners receive cash distributions from the partnership, they pay taxes on those distributions.
C) If money distributions exceed the partner’s basis in the partnership interest, the partner would have to recognize gain on the distribution from the partnership. Such gain is usually an ordinary gain.
D) All of the above are true.
A
A) Distribution of partnership income in the form of cash to partners is generally tax-free to the partners and the partnership.
10
Q
George pays $10,000 for a 20% interest in a general partnership, which has recourse liabilities of $20,000. The partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. George's basis in his partnership interest is A) $10,000. B) $12,000. C) $14,000. D) $30,000.
A
C) $14,000.
Explanation: Beginning basis $10,000 Plus: 20% of liabilities 4,000 George's basis $14,000
11
Q
On January 1, Helmut pays $2,000 for a 10% capital, profits, and loss interest in a partnership, which has recourse liabilities of $20,000. The partners share economic risk of loss from recourse liabilities in the same way they share partnership losses. In the same year, the partnership incurs losses of $6,000 and the recourse liabilities increase by $5,000. Helmut and the partnership use a calendar tax year-end. Helmut's basis at year-end is A) $1,500. B) $2,000. C) $3,500. D) $3,900.
A
D) $3,900.
Explanation: Beginning basis $2,000 Plus: 10% of January 1 liabilities 2,000 Plus: 10% of increase in liabilities 500 Minus: 10% of loss passthrough ( 600) Basis at end of the year $3,900
12
Q
Identify which of the following statements is true.
A) Although a partner’s basis in the partnership cannot go below zero, a partner’s book capital account (equity) may be negative.
B) Tom purchased for cash a 40% capital, profits, and loss interest in the TP General Partnership. His $140,000 basis in his partnership interest includes his $45,000 share of recourse debt and his $30,000 of nonrecourse debt (that is not qualified nonrecourse real estate financing). His at-risk basis cannot be more than $65,000.
C) Terri is a limited partner in the STU Partnership, which manufactures children’s toys. Because the partnership is actively involved in a trade or business, Terri’s income from the partnership is classified as active income for the passive activity loss rules.
D) All of the above are false.
A
A) Although a partner’s basis in the partnership cannot go below zero, a partner’s book capital account (equity) may be negative.
13
Q
Doug purchases a 20% interest in the Quix Partnership for $10,000 on January 1, 2019, and begins to materially participate in the partnership’s business. The Quix Partnership uses the calendar year as its tax year. At the time of the purchase, the Quix Partnership has $4,000 in liabilities, and Doug’s share is 20%. What is Doug’s basis in his partnership interest on January 1, 2010?
A
Answer:
Purchase of partnership interest $10,000
Plus: share of liabilities (0.20 × $4,000) 800
Basis in partnership interest on January 1 $10,800
14
Q
Dan purchases a 25% interest in the Haymarket Partnership for $20,000 on January 1, 2010, and begins to materially participate in the partnership’s business. The Haymarket Partnership uses the calendar year as its tax year. At the time of the purchase, the Haymarket Partnership has $2,000 in liabilities, and Dan’s share is 25%. During the year, the Haymarket Partnership incurs $8,000 in losses and its liabilities increase by $4000. What is Dan’s basis in his partnership interest on December 31, 2010?
A
Answer:
Purchase of partnership interest $20,000
Plus: share of liabilities (0.25 × $2,000) 500
Share of liability increase (0.25 × $4,000) 1,000
Minus: share of partnership losses (0.25 × $8,000) ( 2,000)
Basis in partnership interest on December 31 $19,500
15
Q
Dan purchases a 25% interest in the Haymarket Partnership for $20,000 on January 1, 2010, and begins to materially participate in the partnership’s business. The Haymarket Partnership uses the calendar year as its tax year. At the time of the purchase, the Haymarket Partnership has $2,000 in liabilities, and Dan’s share is 25%. During the year, the Haymarket Partnership incurs $100,000 in losses and its liabilities increase by $4000. What is Dan’s basis in his partnership interest on December 31, 2010?
A
Answer:
Purchase of partnership interest $20,000
Plus: share of liabilities (0.25 × $2,000) 500
Share of liability increase (0.25 × $4,000) 1,000
December 31 basis before losses $21,500
Minus: maximum loss to be deducted (21,500)
Basis in partnership interest on December 31 $ 0
Dan is allocated $25,000 (0.25 × $100,000) of the partnership losses, but he is limited to the amount of the basis in his partnership interest before deduction for the losses. The remaining $3,500 in losses carry over to a subsequent year and are deducted when he has sufficient basis in his partnership interest.
16
Q
Jeremey is a partner in the Jimimey partnership. Why does he need to know his basis in his partnership interest?
A
Jeremey needs to know the basis of his partnership interest in order to determine the amount of partnership losses that he can deduct and the taxability of distributions made to him by the partnership. He also needs to know his basis to determine the gain or loss if he sells his partnership interest.
17
Q
Explain the difference between partnership distributions and distributive shares.
A
Partnership distributions represent the receipt of earnings that have already been taxed to the partners. They reduce each partner’s basis in his or her partnership interest, and generally are tax-free. If the distribution exceeds the partner’s basis in his or her partnership interest, the partner will recognize a gain equal to the amount of the excess. A partner’s distributive share is the portion of the partnership’s taxable and nontaxable items that are allocated to the partner for a given partnership year. Each partner must report and pay taxes on his or her distributive share. The partner’s distributive share is normally determined by the terms of the partnership agreement. If the partnership agreement is silent, all of the facts and circumstances are considered when determining the partner’s overall interest in the partnership. Actual partnership distributions allocated to a partner may be more or less than his or her distributive share for that partnership year.
18
Q
The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date the partner transfers the asset to the partnership.
A
False
19
Q
Identify which of the following statements is true.
A) A contribution of services for a partnership interest is a tax-free transaction.
B) For federal income tax purposes, formation of a partnership is governed by Sec. 721.
C) When a partnership assumes a liability on property contributed by a partner, the only effect on the contributing partner’s basis in his or her partnership interest is that his or her basis will be increased by the amount of the liability assumed by the other partners.
D) All of the above are false.
A
B) For federal income tax purposes, formation of a partnership is governed by Sec. 721.
20
Q
Yong contributes a machine having an adjusted basis of $20,000 and an FMV of $25,000 for a 10% partnership interest. Yong had taken $10,000 of depreciation prior to the contribution. The partnership has no liabilities. As a result of the contribution, Yong must recognize A) no gain or loss. B) a $5,000 Sec. 1245 gain. C) a $5,000 capital gain. D) $10,000 ordinary income.
A
A) no gain or loss.
21
Q
Identify which of the following statements is true.
A) A partner’s relief of debt is treated as if the partner receives a cash distribution.
B) When a partnership assumes any liabilities of the transferor, the transferor has an increase in the basis of his or her partnership interest.
C) Gain recognized by a contributing partner because of the assumption of liabilities by the partnership increases the partnership’s basis in the contributed property.
D) All of the above are false.
A
A) A partner’s relief of debt is treated as if the partner receives a cash distribution.
22
Q
For a 20% interest in partnership capital, profits, and losses, Kasi contributes a machine having a basis of $30,000 and an FMV of $40,000. The partnership also assumes a $24,000 recourse liability secured by the machine. The partnership has $6,000 in recourse liabilities immediately preceding Kasi's contributions. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Kasi's basis in the partnership interest is A) $10,800. B) $12,000. C) $13,200. D) $30,000.
A
B) $12,000.
Explanation: Beginning basis (machine basis) $30,000 Minus: liability assumed by other partners (19,200) Plus: 20% of other partnership liabilities 1,200 Kasi's basis $12,000
23
Q
For a 30% interest in partnership capital, profits, and losses, Carol contributes a machine with a basis of $40,000 and an FMV of $80,000. The partnership assumes a $70,000 recourse liability on the machine. At the time of the contribution, the partnership had recourse liabilities of $10,000. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Following the contribution, Carol has
A) a capital loss due to the contribution of $6,000 and a zero basis in the partnership interest.
B) a capital gain due to the contribution of $6,000 and a zero basis in the partnership interest.
C) a $34,000 basis in the partnership interest and no gain or loss.
D) a $43,000 basis in the partnership interest and no gain or loss.
A
B) a capital gain due to the contribution of $6,000 and a zero basis in the partnership interest.
Explanation: Beginning basis (carryover from machinery) $40,000 Minus: liability assumed by other partners (49,000) Plus: liability assumed by Carol 3,000 Tentative partnership interest basis ($ 6,000)
Capital gain recognized by Carol
$ 6,000
Basis: larger of 0 or ($6,000)
$ 0
24
Q
Stella acquired a 25% interest in the STUV Partnership by contributing land having an adjusted basis of $32,000 and a fair market value of $100,000. The land was subject to a $48,000 mortgage, which was assumed by STUV. No other liabilities existed at the time of contribution. What is Stella's basis in her partnership interest? A) $0 B) $32,000 C) $52,000 D) $64,000
A
A) $0
25
```
David contributes investment land with a basis of $24,000 and an FMV of $40,000 to a partnership for a 10% interest in partnership capital, profits, and losses. The land is subject to a $30,000 recourse liability, which is assumed by the partnership. The partnership has other recourse liabilities of $18,000. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. David must recognize a
A) $3,000 capital gain.
B) $3,000 capital loss.
C) $1,200 capital gain.
D) $1,200 capital loss.
```
C) $1,200 capital gain.
```
Explanation:
Beginning basis (carryover from land)
$24,000
Minus: liability assumed by other partners
(27,000)
Plus: liability assumed by David
1,800
Tentative basis for partnership interest
($1,200)
Capital gain recognized by David
$ 1,200
```
26
```
Rashad contributes a machine having a basis of $30,000 and an FMV of $25,000 to a partnership in exchange for a 20% interest in partnership capital, profits, and losses. Prior to the contribution, the partnership had recourse liabilities of $20,000. The partnership assumes a $20,000 recourse liability that is owed by Rashad on the machine. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Rashad's basis in his partnership interest is
A) $11,000.
B) $18,000.
C) $22,000.
D) $34,000.
```
B) $18,000.
```
Explanation:
Beginning basis (carryover from machine)
$30,000
Plus: share of partnership liabilities
4,000
Minus: liabilities assumed by others partners
(16,000)
Rashad's basis
$18,000
```
27
```
Albert contributes a Sec. 1231 asset to a partnership on June 1 of this year in exchange for a 10% partnership interest. He had purchased the asset on March 1, 2002. His holding period for the partnership interest begins
A) March 1, 2002.
B) March 2, 2002.
C) June 1 of the current year.
D) June 2 of the current year.
```
A) March 1, 2002.
28
```
Mario contributes inventory to a partnership on August 1 of this year in exchange for a 20% partnership interest. Mario had purchased the inventory on July 2 of last year. His holding period for the partnership interest begins
A) July 2 of last year.
B) July 3 of last year.
C) August 1 of the current year.
D) August 2 of the current year.
```
D) August 2 of the current year.
29
Allen contributed land, which was being held for sale to Allen's customers, to a partnership in exchange for a 20% interest. The partnership uses the land in its business for three years and then sells the property. When the property was contributed, it had a basis in Allen's hands of $500,000 and an FMV of $600,000. The partnership sells the land for $700,000. The gain reported by the partnership is
A) $100,000 of ordinary income and $100,000 of Sec. 1231 gain.
B) $100,000 of Sec. 1231 gain and $100,000 of capital gain.
C) $200,000 of ordinary income.
D) $200,000 of Sec. 1231 gain.
C) $200,000 of ordinary income.
```
Explanation:
Amount realized
$700,000
Minus: adjusted basis
(500,000)
Ordinary income
$200,000
```
Land, which is held as inventory by Allen, retains its character as inventory in the hands of the partnership for five years after the contribution.
30
Bao had investment land that he purchased in 1990 for $80,000. Two years ago, when the land was contributed to a partnership, the FMV was $50,000. The land is inventory in the hands of the partnership. The partnership then sells the land in the current year for $46,000. The partnership's recognized loss is
A) a $34,000 capital loss.
B) a $34,000 ordinary loss.
C) a $30,000 capital loss and a $4,000 ordinary loss.
D) a $4,000 capital loss and a $30,000 ordinary loss.
C) a $30,000 capital loss and a $4,000 ordinary loss.
Explanation: The $30,000 precontribution loss retains its character as a capital loss, but the loss accrued since the contribution date is ordinary loss.
31
```
Karl arranges financing for a limited partnership to purchase real estate in exchange for a 50% interest in partnership profits. Two weeks later, Karl sells the profits interest for $30,000. In this tax year, Karl must recognize
A) no gain or loss.
B) a $30,000 short-term capital gain.
C) a $30,000 ordinary income.
D) a $30,000 Sec. 1231 gain.
```
C) a $30,000 ordinary income.
32
Identify which of the following statements is true.
A) The contribution of Sec. 1245 property to a partnership triggers recognition of ordinary income by the contributor at the time of the transfer.
B) A partner may not recognize ordinary income when receiving a capital and profits interest in a partnership in exchange for services.
C) When a partnership interest is given to a partner in exchange for services, the partnership can deduct or capitalize the FMV of the services, depending on the nature of the services.
D) All of the above are false.
C) When a partnership interest is given to a partner in exchange for services, the partnership can deduct or capitalize the FMV of the services, depending on the nature of the services.
33
Ali, a contractor, builds an office building for a construction partnership in exchange for a capital and profits interest in the partnership worth $500,000. Which of the following statements is correct?
A) Ali recognizes $500,000 of ordinary income and the partnership can deduct $500,000 in the current year.
B) Ali recognizes no income and the partnership can deduct nothing in the current year.
C) Ali recognizes $500,000 ordinary income and the partnership deducts the $500,000 over the building's MACRS recovery period as a depreciation expense.
D) Ali recognizes ordinary income in the current year in an amount equal to the depreciation deduction the partnership claims this year for the $500,000 capitalized amount.
C) Ali recognizes $500,000 ordinary income and the partnership deducts the $500,000 over the building's MACRS recovery period as a depreciation expense.
34
Jane contributes land with an FMV of $100,000 and a basis of $80,000 to the Green Partnership in exchange for a 25% partnership interest. The partnership assumes the $40,000 mortgage on the land. Mary has a 25% share of partnership liabilities. The Green Partnership has $8,000 in liabilities immediately before Jane's contribution. What is Jane's basis in her partnership interest?
Basis of contributed property $80,000
Plus: Jane's share of existing partnership liabilities ($8,000 × 0.25) 2,000
Minus: Jane's liabilities assumed by the other partners ($40,000 × 0.75) (30,000)
Jane's basis in her partnership interest $52,000
Jane does recognize any gain on the partnership's assumption of her liability because the deemed cash distribution from the assumption of her $30,000 in liabilities by the partnership does not exceed her $82,000 basis in the partnership interest immediately preceding the fictional distribution.
35
Jane contributes land with an FMV of $100,000 and a basis of $40,000 to the Green Partnership in exchange for a 25% partnership interest. The partnership assumes the $80,000 mortgage on the land. Mary has a 25% share of partnership liabilities. The Green Partnership has $8,000 in liabilities immediately before Jane's contribution. What is Jane's basis in her partnership interest?
Basis of contributed property $40,000
Plus: Jane's share of existing partnership liabilities ($8,000 × 0.25) 2,000
Minus: Jane's liabilities assumed by the other partners ($80,000 × 0.75) (60,000)
Jane's basis in her partnership interest $ 0
The cash deemed distributed in excess of Jane's predistribution basis causes her to recognize an $18,000 ($60,000 - $42,000) gain. Jane reduces her basis to zero since a partner's basis in the partnership interest can never be less than zero.
36
Bob contributes cash of $40,000 and Carol contributes land with a basis of $25,000 and an FMV of $40,000 to become equal partners in the BC Partnership. The partnership immediately obtains a $30,000 mortgage on the land and the partners will share the economic risk of loss equally. What are the two partners' bases in the partnership after these transactions are completed?
```
BOB
Basis of contributed property 40,000
Plus: share of partnership's liability 15,000
Basis in partnership interest
$55,000
Carol
Basis of contributed property 25,000
Plus: share of partnership's liability
15,000
Basis in partnership interest
40,000
```
37
Kay and Larry each contribute property to become equal partners in the KL General Partnership. Kay contributes office furniture with an adjusted basis of $40,000 and an FMV of $50,000, which she has depreciated using MACRS. Larry contributes land with a basis of $60,000 and an FMV of $50,000, which he had been holding as an investment. The partnership will use the land as a parking lot for their business.
a) What is the partnership's basis in each of the two pieces of property?
b) If the land that Larry contributed is sold four years after the contribution for $45,000, what is the amount and character of the gain or loss which Larry should report?
a) The partnership basis for the two assets is a carryover basis from the contributor partners. The office furniture has a basis of $40,000 and the land has a basis of $60,000.
b) Pre-contribution loss of $10,000 is allocated to Larry, and it is a capital loss because Larry held the land as a capital asset prior to its contribution. Capital loss property retains its character for five years after a contribution to a partnership.
The $5,000 post-contribution loss is divided equally between the partners. Since this loss accrued while the partnership held the land as Sec. 1231 property, Larry's $2,500 share of this loss is a Sec. 1231 loss.
38
Sarah purchased land for investment in 2008 for $80,000. In 2009 when the FMV of the land was only $70,000, she contributed it to the SL Partnership, which is in the business of developing and selling lots. SL Partnership developed the contributed land and sold it in 2010 for $50,000. What is the amount and character of the gain or loss?
There is a $30,000 loss ($50,000 - $80,000). The $10,000 loss that accrued while Sarah held the asset retains its character and is a capital loss. The remaining $20,000 of loss is an ordinary loss, as the land was part of the partnership's inventory.
39
George receives a 10% limited partnership interest (capital and profits interest) in the HIJ Partnership in return for managing the partnership's rental property. The partnership interest has an FMV of $35,000. What is the amount and character of the income (if any) that George must report as a result of becoming a partner?
George recognizes $35,000 of ordinary income because the partnership interest is property that he received in exchange for his services.
40
The RT Limited Partnership incurs the following expenses during the time that the partnership is being organized:
Attorneys' fees:
For drawing up the partnership agreement $10,000
For advice on marketing the partnership interests on a stock exchange 14,000
Accountants' fees:
For establishing the accounting system 6,000
For the first quarter's bookkeeping 600
What is the maximum amount that the partnership can deduct as an organization and syndication expense for the first year in which the partnership begins business, assuming the business began on October 1?
The attorneys' fees for drawing up the partnership agreement and the accountants' fees for establishing the accounting system are eligible to be amortized as organization and syndication expenses. $5,000 of the expenses can be deducted in the first year and the remainder amortized over 180 months, resulting in a $61 deduction per month ($11,000/180). The total expense is $5,183 [$5,000 + (61 × 3)]. The accountants' fees for bookkeeping are deductible as trade or business expenses under Sec. 162. The attorneys' advice is deducted when the partnership terminates or is liquidated.
41
Does the contribution of services to a partnership in exchange for an unrestricted partnership interest qualify for Sec. 721 nontaxable treatment?
No. The service partner recognizes income to the extent of the FMV of the partnership interest received less cash or other property contributed by the partner.
42
Explain the tax consequences for both the service partner and the partnership when a contribution of services is made to the partnership.
The service partner has income to the extent of the FMV of an undivided interest in the partnership assets is deemed to have been received. The service partner's basis in their partnership interest equals the amount of income recognized by the service partner.
The partnership recognizes a gain/loss on the assets deemed transferred. The partnership adjusts its basis for the portion of the asset(s) deemed transferred. This adjustment reflects the gain/loss recognized by the partnership on the deemed asset transfer. The partnership will also have a deduction or capital expenditure for the partnership's outlay.
43
Victor and Kristina decide to form VK Partnership. They will be equal partners. Victor contributes a building with a $150,000 FMV and a $105,000 adjusted basis to the partnership. The building has a $60,000 mortgage, which the partnership assumes. Kristina contributes land with a $70,000 FMV and a $95,000 adjusted basis. Kristina will manage the day-to-day activities of the partnership. She will begin to receive a guaranteed payment for her work, starting in the second year of operations, and continuing on as long as she manages the operations of the partnership. Victor and Kristina have agreed that the guaranteed payment will be $10,000 per year. What tax issues should Victor, Kristina, and the partnership consider with respect to the formation and operation of the partnership?
* Does Victor recognize any gain on the formation? When will his precontribution gain be recognized?
* What is Victor's basis and holding period for his partnership interest?
* Does Kristina recognize any loss on the contribution of property in exchange for her partnership interest? When will her precontribution loss be recognized? What will the character of the loss be?
* What is Kristina's basis and holding period for the partnership interest she received in exchange for property?
* What basis and holding period does the partnership have in the property received?
* What happens to the depreciation recapture for the building?
* Did Kristina receive any of her partnership interest for services?
* If so, what gain/loss/deductions must the partnership recognize?
* What income must Kristina recognize?
Victor must determine his basis in the partnership interest ($75,000 = $105,000 - $60,000 + $30,000 share of liabilities) and his holding period for his interest in the partnership (begins with his ownership of the office building). Since Victor recognizes no gain or loss, he does not have to be concerned with any recapture potential under Sec. 1250. Victor will have to recognize precontribution gain on the office building at a future date.
Kristina must determine her basis in the partnership interest ($125,000 = $95,000 + $30,000 share of liabilities) and her holding period for her interest in the partnership (begins with her ownership of the land). Kristina recognizes no loss at the time of the partnership formation. If the land was a capital asset to Kristina and the land is sold by the partnership within five years of Kristina's contribution, the loss will be a capital loss up to $25,000, and that capital loss will be allocated to Kristina as a precontribution loss. After five years, the character of the loss will be determined by the character of the land to the partnership, but Kristina will still have to report any precontribution loss. Guaranteed payments will be reported as ordinary income.
The partnership must be concerned with the basis and holding period of the assets it receives (carryover for both basis and holding period). The partnership can deduct from ordinary income the guaranteed payments made to Kristina.
An additional tax issue must be addressed. Victor contributed property with a net value of $90,000 for a one-half interest in the partnership, while Kristina contributed property with a net value of only $70,000 for a one-half interest in the same partnership. The total partnership has a net value of $160,000 ($150,000 + $70,000 - $60,000 liability). There must be some explanation. One possibility is that Bob has made a $10,000 gift to Kristina. If this is so, both partners' bases must be adjusted to reflect the gift. Alternatively, the facts suggest that Kristina may be receiving some of her partnership interest in exchange for her services in managing the business for the first year while receiving no guaranteed payment. If this is so, Kristina must recognize ordinary income and increase her basis for the value of the partnership interest she received in exchange for services. If Kristina is receiving some of her partnership interest for services, the partnership must recognize a gain or loss in the partnership assets she is deemed to receive and must adjust the basis of the assets for her deemed re-contribution. The partnership also must deduct the guaranteed payment.
44
When the PDQ Partnership formed, it knew it had a good product, but it was a bit short on cash. After seeing the product, Jim, a CPA, said that he would set up an accounting system for the partnership in exchange for a 15% profits interest in the partnership. The partners agreed to this, as Jim was receiving only a profits interest and not a capital interest in the partnership. Jim's usual fee for this type of service would be approximately $5,000. What tax issues should Jim and the PDQ Partnership consider with respect to the payment made for the services?
* Is the receipt of a profits interest in the PDQ Partnership in exchange for Jim's services a taxable event?
* If it is a taxable event, what is the amount and character of the income recognized?
* What is Jim's basis and holding period for his partnership interest?
The receipt of the partnership interest is not a taxable event. Under Rev. Proc. 93-27 (1993-2 C.B. 343), the receipt of a profits interest is taxable only under circumstances where the FMV of the interest can be readily determined. This situation does not fit into one of the three exceptions contained in the revenue procedure guidelines as being a taxable event.
45
Jason, a lawyer, provided legal services for the employees of the ABC Partnership during the first six months of the current year. In exchange, he received a 2% capital and profits interest in the partnership. The value of the interest is $5,000. What are the tax consequences to Jason, the ABC Partnership, and the employees of ABC?
Jason must include the $5,000 in his current-year gross income. The legal services were a fringe benefit to the employees and therefore, not taxable to them. The ABC Partnership can deduct the $5,000 in the current year and will allocate the $5,000 expense to all partners other than Jason.
46
Dinia has agreed to provide services valued at $30,000 to the L-M Partnership. On January 1 of the current year, she is given a 20% capital and profits interest in the partnership in exchange for her services. The partnership has no liabilities at the time but has assets with a basis of $50,000 and an FMV of $70,000. What are the tax consequences to Dinia and the partnership?
The transaction is taxed as if Dinia received a one-fifth interest in each asset. She is taxed on the $30,000 FMV of the assets and takes a $30,000 basis in the partnership interest. The partnership must recognize $4,000 of gain [0.20 × ($70,000 FMV - $50,000 basis)] on the assets deemed paid to Dinia. The partnership calculates gain or loss for each asset it holds, and the character of each asset determines the character of the gain or loss recognized. The partnership's original basis in its assets ($50,000) is increased by the $4,000 recognized gain.
47
Mary and Martha, who had been friends for years, decided to open a retail store to sell kitchen and bath items. In June, they spent $500 looking for a suitable location. They paid an attorney $1,500 to have their partnership agreement drawn up, and they paid an accountant $400 to set up their accounting system. During July, they searched for vendors for the merchandise they planned to carry and stocked their shelves. The store opened in August and was immediately successful. They paid the accountant $300 to prepare an income statement for August. What tax issues should the partnership consider with regard to beginning this business?
* What items qualify as organizational expenses, which are start-up expenses, and what items can be expensed now?
* Does the partnership want to amortize organizational expenses and/or start-up expenses? If so, over what time period does the amortization occur?
* When does the partnership business begin?
The partnership must first characterize each expense as an organizational expense, a start-up expense (Chapter C3), another expense to be capitalized, or as a current-period expense. The costs of drawing up the partnership agreement and of establishing the accounting system are organizational expenses. The expenses of searching for a location is a start-up expense, and the expense of having an income statement prepared is a current-period expense.
A partnership can elect to deduct the first $5,000 of organizational expenses and amortize the excess over 180 months. If the amount of organizational expenses exceeds $50,000, the total amount by which the organizational expenses exceed $50,000 reduces the $5,000 deduction limit.
Another issue the partnership must face is when the partnership is considered to begin business. Regulation Sec. 1.709-2(c) states that business begins when the partnership "starts the business operation for which it was organized." Amortization of both the organizational expenses and the start-up expense begins with the month in which business begins.
48
```
Bob, Kara, and Mark are partners in the BKM Partnership. Bob is a 40% partner and has a June 30 tax year-end. Kara owns a 40% interest in the partnership and has a September 30 tax year-end, and Mark owns the remaining 20% interest and has an October 31 tax year-end. The partnership does not have a natural business year. What is the required tax year-end for the partnership (if no Sec. 444 election is made)?
A) June 30
B) September 30
C) October 31
D) December 31
```
A) June 30
Explanation: The least aggregate deferral for the alternative tax year-ends is:
```
June 30
2.0
September 30
3.8
October 31
7.6
December 31
8.0
```
The smallest of the four alternatives is June 30.
49
Identify which of the following statements is true.
A) The Fisher Partnership is owned equally by four individual partners. Two of the partners have fiscal years ending March 31 and two partners have fiscal years ending June 30. The partnership has a natural business year. The partnership must adopt a calendar year for tax reporting purposes unless a Sec. 444 election is made.
B) Partnerships make most of the tax elections for the partnership rather than the partners.
C) A partner can elect the depreciation method to be applied to the partner's share of the partnership's depreciable assets.
D) All of the above are false.
B) Partnerships make most of the tax elections for the partnership rather than the partners.
50
Charles Jordan files his income tax return on a calendar-year basis. He is a principal partner in a partnership using a tax year ending June 30. Jordan's share of the partnership's ordinary income was $24,000 for the fiscal year ending June 30 of last year and $72,000 for the fiscal year ending June 30 of the current year. Assume the partnership earned its income evenly throughout the year. How much should Jordan report on his Form 1040 for last year as his share of the partnership's ordinary income?
$24,000 of partnership ordinary income from the partnership return for the year ending June 30 of last year. None of the income for the July 1 - December 31 portion of the partnership return for the year ending June 30 of this year is included in the partner's return for last year.
51
The XYZ Partnership is held by ten partners who have the following capital and profits ownership of the partnership. The tax year-end used by each of the ten partners is also indicated. Assume each partner has used this year-end for at least five years.
```
Partner
Ownership
Partner's Tax Year-End
A
B
C
D
E
F
G
H
I
K
8%
8%
8%
10%
10%
10%
10%
12%
12%
12%
12/31
6/30
9/30
6/30
6/30
10/31
9/30
12/31
6/30
6/30
```
What is the required year-end for the XYZ Partnership, assuming that the business has no natural business year and has not filed a Sec. 444 election?
The partnership's required year-end under Sec. 706 is June 30 because a majority of the partnership interests (52%) are held by partners (B, D, E, I, and K) with that year-end.
52
What are the three rules and their order when determining a partnership tax year?
First, the partnership tax year will be the majority (own in the aggregate more than 50%) partner's (or partners')tax year. If the first rule is not applicable, then it will be the tax year of all principal partners (5% or more partners). If neither of the preceding rules is applicable, then it will be the tax year that allows the least aggregate deferral.
53
A partnership cannot make charitable contributions.
False
54
Identify which of the following statements is true.
A) A partnership cannot have an NOL carryback or carryforward.
B) A partnership cannot make charitable contributions.
C) Dividends received by a partnership from a domestic corporation are included in the partnership's ordinary income.
D) All of the above are false.
A) A partnership cannot have an NOL carryback or carryforward.
55
Identify which of the following statements is true.
A) Tax-exempt interest received by a partnership is taxable to the partners if distributed.
B) Partnership gains and losses from two different casualty and theft occurrences in one year are passed through to the partners as two separate items.
C) The amount and character of any gains/losses is determined at the partnership level.
D) All of the above are false.
C) The amount and character of any gains/losses is determined at the partnership level.
56
```
Matt and Joel are equal partners in the MJ Partnership. For the current year ended December 31, the partnership has book income of $80,000, which includes the following deductions: (1) guaranteed payments (salaries) to partners: Matt, $35,000; and Joel, $25,000; and (2) charitable contributions, $6,000. The book income amount does not include any sales of capital assets or Sec. 1231 assets or any tax-exempt income. Based on the above information, what amount should be reported as ordinary income on the partnership return?
A) $60,000
B) $80,000
C) $86,000
D) $140,000
```
C) $86,000
```
Explanation:
Book income
$80,000
Plus: charitable contributions
6,000
Ordinary income
$86,000
```
57
Identify which of the following statements is true.
A) A partner's distributive share includes the full amount of partnership ordinary income, which she must report on her tax return plus her share of separately stated taxable and tax-exempt items.
B) Sam has a 20% interest in partnership capital and profits but a 40% interest in partnership losses. The partnership has no special allocations or precontribution gains or losses. In a year in which the partnership reports ordinary income of $100,000 and a capital loss of $30,000, Sam's distributive share is $20,000 ordinary income and $12,000 capital loss.
C) The partner's distributive share is the partner's share of any assets distributed by the partnership.
D) All of the above are false.
A) A partner's distributive share includes the full amount of partnership ordinary income, which she must report on her tax return plus her share of separately stated taxable and tax-exempt items.
58
```
In computing the ordinary income of a partnership, a deduction is allowed for
A) net Sec. 1231 losses.
B) bad debts.
C) foreign income taxes paid.
D) charitable contributions.
```
B) bad debts.
59
```
AT Pet Spa is a partnership owned equally by Travis and Ashley. The partnership had the following revenues and expenses this year. Which of the following items are separately stated? Nonseparately stated? What is each partner's distributive share of ordinary income?
Revenues $500,000
Salary expense (nonpartners) 250,000
Supplies 40,000
Insurance 50,000
Depreciation (no Sec. 179 amounts) 10,000
Dividend income 2,000
Long-term capital gain 30,000
```
Separately-stated items are the dividend income, long-term capital gain. and the partnership's ordinary income. The remaining items are nonseparately stated. The partnership's ordinary income is:
```
Revenues $500,000(C)
Salary expense (nonpartners) 250,000(D)
Supplies 40,000(D)
Insurance 50,000(D)
Depreciation (no Sec. 179 amounts) 10,000(D) 350,000(C)
Partnership ordinary income $150,000(C)
```
60
The WE Partnership reports the following items for its current tax year:
```
Income
Operating income $90,000
Rental income 15,000
Interest income:
Tax-exempt municipal bonds 2,000
Corporate bonds 4,000
Sec. 1231 gain 20,000
Sec. 1245 gain 18,000
Long-term capital gain 7,000
```
Expenses
Rental expenses 12,000
Salaries paid to employees (not partners) 30,000
Charitable contributions 5,000
Interest paid related to borrowings used to finance municipal bonds 3,000
What is the WE Partnership's ordinary income for the current year?
The income items, which are ordinary, total $108,000 ($90,000 operating income + $18,000 Sec. 1245 gain). The only ordinary expense is the $30,000 of salaries. Accordingly, partnership ordinary income totals $78,000 ($108,000 - $30,000).
61
Briefly explain the aggregate and entity theories as they relate to partnerships.
The aggregate theory of partnerships holds that the partnership is merely an aggregate of its partners, thus the partnership's income flows through to its partners. The entity theory views a partner's separate entity from its partners, thus the partnership makes elections at the entity level.
62
What is included in partnership taxable income?
Partnership taxable income includes both the separately stated items and the partnership's ordinary income or loss. The ordinary income or loss is the sum of all taxable items that are not separately stated.
63
ABC Partnership distributes $12,000 to partner Al. Al's distributive share of partnership income is $20,000. Al is taxed on $20,000.
True
64
A partner's "distributive share" is the partner's share of any assets distributed by the partnership.
False
65
Identify which of the following statements is true.
A) The Hunter Partnership has a net long-term capital gain of $4,000 and a net short-term capital loss of $1,000 for the current tax year. The gain and loss will be netted and the partners will include their proportionate share of the $3,000 net long-term capital gain on their return.
B) The Right Partnership sells a delivery truck and recognizes a gain of $2,000, which represents depreciation recaptured under Sec. 1245. The $2,000 gain will retain its identity as a separately stated item.
C) For tax purposes, the partnership takes a carryover basis in the contributed property that references the contributing partner's basis.
D) All of the above are false.
C) For tax purposes, the partnership takes a carryover basis in the contributed property that references the contributing partner's basis.
66
```
On January 2 of the current year, Calloway and Taylor contribute cash equally to form the CT Partnership. Calloway and Taylor share profits and losses in a ratio of 75% and 25%, respectively. The partnership's ordinary income for the year was $40,000. Calloway received a distribution of $5,000 during the year. What is Calloway's share of taxable income for the year?
A) $5,000
B) $10,000
C) $20,000
D) $30,000
```
D) $30,000
67
The XYZ Partnership reports the following operating results for the current year:
```
Net long-term capital loss
($40,000)
Net Sec. 1231 loss
( 16,000)
Ordinary income
50,000
```
```
Tai has a 20% profits interest and a 25% loss interest in the XYZ Partnership. His distributive share of ordinary income is
A) $6,800.
B) $8,500.
C) $10,000.
D) $12,500.
```
D) $12,500.
Explanation: Since the partnership has a net loss [($40,000) + ($16,000) + $50,000 = ($6,000)] for the year, Tai's distributive share of the $50,000 of ordinary income is calculated using the 25% loss interest.
68
```
Latoya owns a 10% interest in the ABC Partnership from January 1 through June 30 (the 181st day of the tax year) of the current year (a non-leap year). On July 1, Latoya buys an additional 10% interest in the partnership. The XYZ Partnership's ordinary income is $109,500 and it is earned evenly throughout the year. Latoya's distributive share of the ordinary income is
A) $16,380.
B) $16,425.
C) $16,470.
D) $21,900.
```
C) $16,470.
```
Explanation:
$109,500 × 181/365 × 0.10 =
$ 5,430
$109,500 × 184/365 × 0.20 =
11,040
Total
16,470
```
69
```
On December 1, Antonio, a member of a three-person partnership, purchases investment securities from the partnership for their $37,000 FMV. All partners share profits and losses equally. The securities were acquired by the partnership for $25,000 cash in March of the current year. What amount and character of gain will Antonio recognize because of this transaction?
A) $0 gain
B) $4,000 ordinary income
C) $4,000 short-term capital gain
D) $12,000 ordinary income
```
C) $4,000 short-term capital gain
($37,000 - $25,000) × 1/3 = $4,000 short-term capital gain from the sale of securities.
70
Meg and Abby are equal partners in the AM Partnership, which earns $40,000 ordinary income, $6,000 long-term capital gain (LTCG), and $2,000 Sec. 1231 loss during the current year. What is the amount and character of income that must be reported on Abby's tax return for this year's partnership operations?
A) $20,000 ordinary income, $3,000 LTCG, $1,000 Sec. 1231 loss
B) $19,000 ordinary income, $3,000 LTCG
C) $23,000 ordinary income, $1,000 Sec. 1231 loss
D) $22,000 ordinary income
A) $20,000 ordinary income, $3,000 LTCG, $1,000 Sec. 1231 loss
71
On December 31 of last year, Alex and Jackson become equal partners in the AJ Partnership with assets having a tax basis and FMV of $120,000. The partnership, which deals in securities, had no liabilities at the end of last year. In January of this year, Franklin contributes his investment securities with an FMV of $60,000 (purchased two years ago at a cost of $45,000) to become an equal partner in the new AJF Partnership. The securities, which are inventory to the partnership, are sold on December 15 of the current year for $90,000. What amount and character of gain from the sale of these securities should be allocated to Franklin?
A) $10,000 ordinary income
B) $15,000 capital gain and $10,000 ordinary income
C) $25,000 capital gain
D) $25,000 ordinary income
```
D) $25,000 ordinary income
Explanation:
Precontribution gain
$15,000
Plus: one-third of the postcontribution gain
10,000
Total gain recognized by Jackson
$25,000
```
There is no special provision to preserve the capital gain character for Jackson, so the entire gain is ordinary income.
72
```
At the formation of the BD Partnership, Betty contributes land with a basis of $10,000 and an FMV of $30,000 and Dick contributes cash of $30,000. Betty and Dick share profits and losses equally. When the land is sold two years later for $50,000, Betty must recognize a gain of
A) $10,000.
B) $20,000.
C) $30,000.
D) $40,000.
```
C) $30,000.
```
Explanation:
Precontribution gain ($30,000 - $10,000)
$20,000
Plus: one-half of the postcontribution gain
10,000
Total gain recognized by Betty
$30,000
```
73
Identify which of the following statements is false.
A) Jean and Blossom form an equal partnership. Jean contributes $10,000 cash and Blossom contributes property with a $10,000 FMV and a $5,000 basis. When the partnership sells the property contributed by Blossom for $10,000 shortly after the formation, Blossom must include the $5,000 gain in her income.
B) In order to shift income/loss between partners, there must be substantial economic effect.
C) The BB Partnership wants to make a special allocation of $10,000 of long-term capital gain to Bob and a special allocation of $10,000 of ordinary income to Briana. This allocation will have a substantial economic effect.
D) Partners must make up negative balances in their capital accounts upon liquidation of the partnership.
C) The BB Partnership wants to make a special allocation of $10,000 of long-term capital gain to Bob and a special allocation of $10,000 of ordinary income to Briana. This allocation will have a substantial economic effect.
74
Elijah contributes securities with a $90,000 FMV (purchased in 2008 at a cost of $50,000) to become a one-third partner in the EJK Partnership on January 1 of the current year. The securities are sold on December 15 of the current year for $105,000. How much of the partnership's capital gain from the sale of these securities should be allocated to Elijah?
($90,000 - $50,000) + [($105,000 - $90,000) × 0.333] = $45,000.
75
Under what conditions will a special allocation of partnership depreciation be recognized? Assume the partnership has no non-recourse liabilities.
A special allocation must be stated in the partnership agreement or the amount will be allocated in accordance with the partners' interest in the partnership. In addition, the allocation must have substantial economic effect. To have economic effect, the allocation must meet all of the following requirements throughout the term of the partnership:
• Capital accounts must be maintained under the capital account maintenance rules of the Sec. 704 regulations.
• Upon liquidation of the partnership, liquidating distributions must be made in accord with positive capital accounts.
• If a partner has a deficit capital account balance after all adjustments for the year of liquidation, that partner must be unconditionally obligated to restore the deficit. (The regulations provide some alternatives to an unconditional obligation to restore the deficit, but the alternatives are not covered in this introductory textbook.)
For the economic effect of the special allocation to be considered substantial, there must be a reasonable possibility that the allocation will substantially affect the dollar amounts to be received by the partners independent of any tax consequences.
76
Tracy has a 25% profit interest and a 20% loss interest in the Dupont Partnership. The Dupont Partnership reports the following income and loss items for the current year:
Net long-term capital loss $50,000
Net Sec. 1231 gain 45,000
Ordinary income 110,000
What is Tracy's distributive share?
The partnership has a $105,000 ($110,000 + $45,000 - $50,000) net profit for the year. Tracy's distributive share is calculated using her profits interest percentage, 25%.
Net long-term capital loss $12,500
Net Sec. 1231 gain 11,250
Ordinary income 27,500
The loss percentage is only used in years in which the partnership has a net loss.
77
Mike and Jennifer form an equal partnership. Mike contributes cash of $15,000 and Jennifer contributes land having a $15,000 FMV and a basis of $5,000. If the partnership sells the land three years later for $18,000, what are the tax consequences to Mike and Jennifer?
The precontribution gain of $10,000 ($15,000 - $5,000) is allocated only to Jennifer. The $3,000 gain that accrued while the partnership held the land ($18,000 - $15,000) is allocated equally to Mike and Jennifer. Jennifer's total gain is $11,500 and Mike's gain is $15,000.
78
A partner's share of nonrecourse debt increases that partner's share of basis.
True
79
A partner's basis for his or her partnership interest is increased by his share of the partnership's tax-exempt income.
True
80
```
William and Irene each contribute $20,000 cash to the WI Partnership on January 1 of last year. William and Irene share profits and losses equally. Last year, the partnership reported tax-exempt interest income of $4,000. This year, each partner receives $1,000 of the tax-exempt interest income in a cash distribution. There are no partnership liabilities and no other income, loss, contributions, or distributions during both years. William's basis in the partnership interest following these transactions is
A) $19,000.
B) $20,000.
C) $21,000.
D) $22,000.
```
C) $21,000
```
Explanation:
Beginning basis
$20,000
Plus: one-half of tax-exempt interest income
2,000
Minus: distribution
( 1,000)
Postdistribution basis
$21,000
```
81
```
Miguel has a 50% interest in partnership capital, profits, and losses. The basis for his partnership interest is $50,000. The partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Miguel receives a distribution of land that has an FMV of $40,000 and an adjusted basis of $30,000. The land is subject to a $15,000 liability, which Miguel assumes. His basis in the partnership interest following the land distribution is
A) $12,500.
B) $20,000.
C) $27,500.
D) $35,000.
```
```
C) $27,500.
Explanation:
Pre-distribution basis
$50,000
Minus: distribution
(30,000)
Minus: release from one-half of partnership
liability for land
( 7,500)
Plus: liability assumed from partnership
15,000
Post-distribution basis
$27,500
```
82
Identify which of the following statements is true.
A) A general partner's share of recourse debt is based on his or her economic risk of loss, and his or her share of nonrecourse debt is predominantly based on his or her share of partnership profits.
B) A partner's basis for his or her partnership interest is increased by his or her share of the partnership's tax-exempt income.
C) If all tax-exempt interest income is distributed when received by a partnership, the partners' bases are the same after the distribution as they were before the tax-exempt interest was received by the partnership.
D) All of the above are true.
D) All of the above are true.
83
Identify which of the following statements is true.
A) When adjusting a partner's basis in a partnership interest, the negative basis adjustments are made prior to the positive basis adjustments.
B) Martin and Carlos formed an equal partnership to which Martin contributed $10,000 cash and Carlos contributed a building worth $10,000 with a basis of $2,000. In the first year of operation, the partnership suffered a $10,000 ordinary loss. Martin and Carlos can each deduct a $5,000 loss on their personal tax returns.
C) Any distributive share of a loss that cannot be deducted by a partner because of the Sec. 704(d) basis loss limitation is permanently lost.
D) All of the above are false.
D) All of the above are false.
84
```
Stan had a basis in his partnership interest at the beginning of last year of $30,000. There was no change in partnership liabilities during the year. His share of the partnership's ordinary loss last year was $40,000 and the partnership had no separately stated items. This year, Stan has a distributive share of ordinary income of $30,000. The taxable income from the partnership reported on Stan's personal income tax return this year (ignoring the at-risk and passive activity loss limitations) is
A) $10,000 ordinary loss.
B) $20,000 ordinary income.
C) $30,000 ordinary income.
D) $40,000 ordinary income.
```
B) $20,000 ordinary income.
Explanation: $30,000 - $10,000 loss carryover = $20,000.
```
Beginning basis
$30,000
Minus: share of loss deducted last year
(30,000)
End-of-year basis (last year)
0
Plus: share of current-year income
30,000
Minus: loss carryover from last year
(10,000)
End-of-year basis (this year)
$20,000
```
85
```
A partnership has one general partner, Allen, who materially participates in the business. Allen had a $30,000 distributive share of ordinary losses for this year and the partnership had no separately stated gains or losses. There are no changes in liabilities during this year and there are no additional contributions or distributions. At the beginning of this year, the Sec. 705 basis was $40,000 and the at-risk basis was $15,000. The basis on December 31 of this year based on the above information is
A) $10,000.
B) $15,000.
C) $25,000.
D) $40,000.
```
A) $10,000.
Explanation: $40,000 - $30,000 = $10,000
86
Clark and Lewis are partners who share the profits and losses of the C&L Partnership 60% and 40%, respectively. The tax basis of each partner's interest in the partnership as of December 31 of last year was as follows: Clark, $14,000; Lewis, $12,000. During the current year, the partnership had ordinary income of $20,000 and a long-term capital loss of $10,000 from the sale of securities. The partnership made cash distributions proportionately to the two partners during this year totaling $20,000. What is the amount of Lewis's tax basis of his partnership interest on December 31 of the current year?
Lewis's basis = $12,000 + (0.40 × $20,000) - (0.40 × $10,000) - $8,000 distributions = $8,000
87
The partners of the MCL Partnership, Martin, Clark, and Lewis, share profits and losses in a ratio of 4:3:3, respectively. The tax basis of each partner, as of December 31 of the current year, is as follows: Martin, $7,200; Clark, $6,000; and Lewis, $2,500. During the current year, the partnership incurred an ordinary loss of $15,000. The loss is not reflected in the tax basis figures presented above. Nothing else occurs during the year that would affect the partners' bases. As a result of this loss, what amount should Martin, Clark, and Lewis report on their individual tax returns for the current year? What limitations (other than the Sec. 704(d) loss limitations) may prevent them from deducting their losses in the current year?
The loss allocation is:
Martin: $15,000 × 0.40 = $6,000
Clark: $15,000 × 0.30 = $4,500
Lewis: $15,000 × 0.30 = $4,500
Martin and Clark are limited to deducting $6,000 and $4,500, respectively, by their allocation of the partnership loss and not by their bases for their partnership interests under Sec. 704(d). Lewis, on the other hand, has his $4,500 share of the partnership loss limited by his $2,500 basis for the partnership interest under Sec. 704(d). These amounts may be further restricted by the at-risk rules and the passive activity limitations.
88
The Troika Partnership has an ordinary loss of $48,000 for the year. Before allocation of the loss at the end of the year, Shaad's one-third limited partnership interest has an adjusted basis of $5,000. Shaad's only other income or loss is his $30,000 salary from a factory job. What amount can Shaad deduct on his tax return as his share of the partnership's loss?
Shaad's distributive share of loss is $16,000 ($48,000 × 0.333). His loss deduction is first limited to his $5,000 adjusted basis under Sec. 704(d). His loss is further restricted by the passive loss rules and, since he has no passive income, he cannot deduct any of the loss from this partnership.
89
Explain the three different limitation provisions that a partner must satisfy before a loss can be deducted.
In the order of application, these limitations are: (1) adequate partnership basis under Sec. 704(d), (2) the at-risk loss limitations, and (3) the passive activity limitations.
90
Jerry has a 10% interest in the EKG Partnership capital, profits, and losses. He is a limited partner. At the beginning of the current year, his basis in his partnership interest is $10,000. The partnership earned $20,000 of ordinary income this year and repaid a $150,000 nonrecourse liability. What tax issues should Jerry consider with respect to reporting the results of this year's activities for the EKG Partnership on his personal return?
* What is Jerry's basis in his partnership interest?
* Does the repayment of the partnership liability cause an adjustment to Jerry's basis in his partnership interest?
* Is the repayment of the nonrecourse liability a taxable event for Jerry? If so, what are the amount and character of the income reported?
Repayment of partnership liabilities is treated as distributions to the partners. A distribution made to a partner that exceeds their basis for the partnership interest produces a taxable gain. The gain can be calculated as follows:
```
Basis at the beginning of the year $10,000
Plus: George's share of income
(0.10 × $20,000) 2,000
George's basis before the distribution $12,000
Minus: George's deemed distribution from
repayment of partnership liability
(0.10 × $150,000) (15,000)
George's recognized gain $ 3,000
```
91
Samantha works 40 hours a week as a clerk in the mall and earns $28,000. In addition, she works five hours each week in the XYZ Partnership's office. Samantha, a 15% limited partner in the XYZ Partnership, has been allocated a $4,000 loss from the partnership for the current year. The basis for her interest in XYZ before accounting for current operations is $7,000. What tax issues should Samantha consider with respect to her interest in, and employment by, the XYZ Partnership?
* What is Samantha's deductible loss from her partnership investment?
* What is Samantha's Sec. 704(d) basis in her partnership interest?
* What is Samantha's at-risk basis in her partnership interest?
* Is the loss from the XYZ Partnership a passive loss?
* Does Samantha have passive income from this investment or other investments? If so, can she deduct her losses? If not, do the losses carry over to later years?
As a limited partner, Samantha is presumed not to materially participate in the partnership. Therefore, because it is a loss from a passive activity, her loss cannot be deducted unless she has passive income from other investments, or she terminates her interest in the limited partnership. If no such income exists, the losses carry over to later years.
92
At the beginning of the current year, Terry has a $40,000 basis for his general partnership interest in the TKE Partnership. He materially participates in the business activities of the partnership. On November 1, he receives a $4,000 distribution. His distributive share of TKE's current items is a $5,000 net long-term capital gain and a $50,000 ordinary loss. What amount will he include in his current year's tax return?
Terry has a $41,000 ($40,000 + $5,000 - $4,000) basis in his partnership interest at the end of the year before including the ordinary loss. His loss deduction is limited to his basis. Therefore, he will include the $5,000 long-term capital gain and $41,000 of the ordinary loss. The remaining $9,000 ordinary loss can be deducted in the following year if he has sufficient basis in his partnership interest.
93
Limited partners must consider the at-risk, basis, and passive loss limitations when determining the amount of their deductible loss.
True
94
No gain is recognized on the sale of property between a partnership and a more-than-50% partner.
False
95
Martin is a limited partner in a card shop. At the end of the partnership's tax year, Martin's basis in the partnership interest is $25,000 ($5,000 cash investment plus a $20,000 share of nonqualified nonrecourse financing). Martin's distributive share of partnership losses for the tax year is $33,000. Martin has $30,000 of passive income this year from other activities. How much of the $33,000 partnership loss can be used by Martin in the year of the loss?
A) $5,000
Explanation: Martin's total basis under Sec. 704(d) is $25,000. However, his $5,000 cash investment is the only amount for which he is at risk under the at-risk rules and sets the limit on his loss deduction, since he has $30,000 of passive income.
96
```
David purchased a 10% capital and profits interest in a partnership this year. He does not participate in the partnership's business. David has no passive income in the current year. His distributive share of the partnership's loss is $40,000 for this year. David's Sec. 705 basis in the partnership is $32,000 and his at-risk basis is $16,000 at the end of the current year. How much of the loss can David deduct on his tax return?
A) $0
B) $16,000
C) $32,000
D) $40,000
```
A) $0
David's passive loss limitation is zero and is the controlling factor
97
Guaranteed payments are always ordinary income to the recipient.
True
98
Jangyoun sells investment land having a $30,000 basis to a partnership in which he has a 60% partnership interest. The partnership pays $26,000 (FMV) for the land. Later, the partnership sells the investment land to a nonpartner for $31,000. On the sale of the land, the partnership must recognize a
A) $0 gain or loss.
B) $1,000 capital gain.
C) $4,000 capital gain and $1,000 Sec. 1231 gain.
D) $5,000 capital gain.
B) $1,000 capital gain.
```
Explanation:
Amount realized
$31,000
Minus: basis to partnership
(26,000)
Realized gain
$ 5,000
```
Jangyoun realized a $4,000 loss ($26,000 - $30,000) on the sale of the land to the partnership. The $4,000 loss is disallowed in the year of Jangyoun's sale, but can offset the partnership's realized gain, thus reducing it to a $1,000 recognized gain. The gain is capital because the land was held for investment purposes by the partnership.
99
Identify which of the following statements is true.
A) A partner who performs services for a partnership is usually not considered an employee of the partnership.
B) It may be necessary for the partnership to capitalize a partner's guaranteed payment.
C) Guaranteed payments are ordinary income to the recipient.
D) All of the above are true.
D) All of the above are true.
100
When computing the partnership's ordinary income, a deduction is allowed for
A) contributions to charitable organizations.
B) net operating losses.
C) net short-term capital losses.
D) guaranteed payments to partners.
D) guaranteed payments to partners.
101
When determining the guaranteed payment, which of the following statements is correct?
A) If the distributive share is less than the guaranteed minimum amount, the guaranteed payment is equal to the difference between the distributive share and the guaranteed minimum amount.
B) If the distributive share is greater than the guaranteed minimum amount, the guaranteed payment is equal to the difference between the distributive share and the guaranteed minimum amount.
C) Guaranteed payments are payments determined with regard to the partnership income.
D) The distinction between guaranteed payments and distributive shares is clear in practice.
A) If the distributive share is less than the guaranteed minimum amount, the guaranteed payment is equal to the difference between the distributive share and the guaranteed minimum amount.
102
Yee manages Huang real estate, a partnership in which she is also a partner. She receives 40% of all partnership income before guaranteed payments, but no less than $80,000 per year. In the current year, the partnership reports $400,000 in ordinary income. What is Yee's distributive share and her guaranteed payment?
Distributive Shares, Guaranteed Payment
a. $80,000; 80,000
b. $160,000; $0
c. $160,000; $80,000
d. $160,000; $160,000
b. $160,000; $0
103
Yee manages Huang real estate, a partnership in which she is also a partner. She receives 40% of all partnership income before guaranteed payments, but no less than $80,000 per year. In the current year, the partnership reports $100,000 in ordinary income. What is Yee's distributive share and her guaranteed payment?
Distributive Shares, Guaranteed Payment
a. $40,000; $0
b. $40,000; $80,000
c. $40,000; $40,000
d. $0; $80,000
c. $40,000; $40,000
104
In January of this year, Arkeva, a calendar-year taxpayer, receives a $50,000 guaranteed payment from NFR Partnership. NFR deducted the payment during its tax year ending November 30 of last year. What tax year must Arkeva report her guaranteed payment in?
A) She may elect either year.
B) last year
C) current year
D) She does not need to report guaranteed payments on her return.
B) last year
105
Henry has a 30% interest in the HMS Partnership's capital, profits, and losses computed after taking into account his guaranteed payment of $40,000. In the current year, HMS reports ordinary income of $30,000 and capital gains of $60,000 before taking into account Henry's guaranteed payment. What is the amount and character of all income or loss that Henry must report as a result of partnership activities?
A) $40,000 guaranteed payment (ordinary income), $3,000 ordinary loss, $18,000 capital gain
B) $40,000 guaranteed payment (ordinary income), $15,000 capital gain
C) $40,000 guaranteed payment (ordinary income), $9,000 ordinary income, $6,000 capital gain
D) $13,000 guaranteed payment (ordinary income), $6,001 ordinary income, $38,820 capital gain
A) $40,000 guaranteed payment (ordinary income), $3,000 ordinary loss, $18,000 capital gain
Explanation: OI = $40,000 guaranteed payment; OL = ($30,000 - $40,000) × 0.30 = ($3,000); capital gains = $60,000 × 0.30 = $18,000.
106
Edward owns a 70% interest in the capital, profits, and losses of the Edward and Moore Partnership. During the year, Edward purchases surplus inventory from the partnership for $5,000. On the date of the sale, the inventory has an adjusted basis to the partnership of $8,000. For the year, the partnership's ordinary income is $50,000 after including the loss on the sale of the inventory to Edward. Assuming that there are no other partnership items to be separately stated, what is Edward's distributive share of the partnership's ordinary income for the year?
The loss will not be recognized by the partnership because Edward owns more than 50% of the partnership capital or profits interests and is considered a related party under Sec. 707(b). The partnership has ordinary income of $53,000 ($50,000 + $3,000) of which Edward's share is $37,100 (0.70 × $53,000).
107
In January, Daryl and Louis form a partnership with each contributing $75,000 in cash. The partnership agreement provides that Daryl would receive a guaranteed payment for salary of $20,000 and that partnership profits and losses (computed after deducting Daryl's salary) would be shared equally. For the year, the partnership's operations result in an $18,000 ordinary loss after payment of Daryl's guaranteed payment. The partnership has no outstanding liabilities at year-end. What is the basis amount of Daryl's partnership interest at year-end?
Daryl's basis would be unaffected by the guaranteed payment. It would be reduced by $9,000 for the portion of the ordinary loss that he is allocated and would total $66,000 ($75,000 - $9,000).
108
What is the tax impact of guaranteed payments on the partner and the partnership?
The partner recognizes ordinary income in the partner's tax year during which the partnership tax year ends regardless of when the payment is received. The partnership deducts or capitalizes the guaranteed payments, since it is treated as if it were made to an outsider.
109
Janice has a 30% interest in the Jansen Partnership. She is to receive a guaranteed payment for deductible services of $50,000. The partnership reports $30,000 of ordinary income and a $100,000 long-term capital gain before deducting the guaranteed payment. What is her income from the partnership?
Janice will report the guaranteed payment of $50,000. She will also report her distributive share of the partnership's ordinary loss, $6,000 [0.30 × ($30,000 - $50,000)] and her distributive share of the partnership's long-term capital gain, $30,000 (0.30 × $100,000).
110
Identify which of the following statements is true.
A) Bob gives his 16-year-old daughter Michelle a 20% capital and profits interest in his accounting practice. She does no work for the partnership and is not involved at all with the operations of the partnership. In fact, she does not know that her dad transferred the interest in the partnership to her. If the partnership allocates an $8,000 distributive share of ordinary income to her, it is properly reported on Michelle's individual tax return.
B) Valid family partnership partners may be subject to the "kiddie tax."
C) Joan gives her daughter, Sarah, a 25% interest in a partnership that operates a steel mill. Sarah, age 19, was allocated $20,000 from the partnership as her share of the partnership ordinary income. The IRS will require the income to be included on Sarah's return.
D) All of the above are false.
B) Valid family partnership partners may be subject to the "kiddie tax."
111
```
Nicholas, a 40% partner in Nedeau Partnership, gives one-half of his interest to his sister, Michelle. During the current year, Nicholas performs services for the partnership for which reasonable compensation is $80,000, but for which he accepts no pay. Nicholas and Michelle are each credited with a $100,000 distributive share, all of which is ordinary income. What are Nicholas' and Michelle's distributive share?
Nicholas; Michelle
a. $100,000; $100,000
b. $60,000; $60,000
c. $180,000; $60,000
d. $140,000; $60,000
```
d. $140,000; $60,000
```
Explanation:
Total distributive shares ($100,000 × 2)
$200,000
Minus: reasonable compensation for Nicholas
80,000
Income to allocate
$120,000
```
Nicholas' distributive share [(20%/40%) × $120,000] + $80,000 = $140,000
Michelle's distributive share (20%/40%) × $120,000 = $60,000
112
Bud has devoted his life to his business, the BK Partnership, in which he owns an 85% capital and profits interest. Because he has worked so hard all his life, he never married and has no children. He has decided to give a 25% capital and profits interest to Berry, a close friend, if Berry will work in the business for five years. Berry will receive guaranteed payments for his work. Bud devotes all his time to the partnership, but he takes no salary. What tax issues should Bud and Berry consider with respect to the gift of the partnership interest and Bud's employment arrangement with the partnership?
* Do the family partnership rules apply when there is no family relationship?
* Does reasonable compensation need to be paid to Bud for his services?
* If so, what is reasonable compensation for Bud's services?
* Does Berry need to be recognized as a partner in the BK Partnership?
* If so, what is Berry's allocable share of the partnership income?
* What is Bud's allocable share of the partnership income?
The family partnership rules are written in terms of the donor-donee relationship. Accordingly, they apply in this situation. Both Bud and Berry would be allocated a reasonable compensation amount. Then, the remainder of the income originally allocated to Bud and Berry would be reallocated to them based on their relative capital interests.
113
A partnership must file Form 1065 only if its income exceeds $1,000.
False
114
Brent is a general partner in BC Partnership. His distributive share of partnership income and his guaranteed payment for the year are as follows:
```
Ordinary income
$30,000
Short-term capital gain
$18,000
Guaranteed payment
$36,000
```
```
What is his self-employment income?
A) $84,000
B) $66,000
C) $48,000
D) $36,000
```
B) $66,000
Explanation: ($30,000 + $36,000)
115
Brent is a limited partner in BC Partnership. His distributive share of partnership income and his guaranteed payment for the year are as follows:
```
Ordinary income
$30,000
Short-term capital gain
$18,000
Guaranteed payment
$36,000
```
```
What is his self-employment income?
A) $84,000
B) $66,000
C) $48,000
D) $36,000
```
D) $36,000
