CHAPTER 10--PARTNERSHIPS: FORMATION,
OPERATION, AND BASIS
Student: ___________________________________________________________________________
1. A partnership is an association formed by two or more taxpayers (who may be any type of entity) to carry on
a trade or business.
True False
2. In a limited liability company, all members are protected from all debts of the partnership unless they
personally guaranteed the debt.
True False
3. A limited partnership offers all partners protection from claims by the LP’s creditors.
True False
4. The primary purpose of the partnership agreement is to document the various tax elections made by the
partners regarding depreciation methods, treatment of research and experimental costs, calculation of the § 199
deduction, and the § 754 election.
True False
5. The taxable income of a partnership flows through to the partners, who report the income on their tax
returns.
True False
6. An example of the “aggregate concept” underlying partnership taxation is the fact that the partners (rather
than the partnership) pay tax on partnership income.
True False
7. Each partner’s profit-sharing, loss-sharing, and capital-sharing ownership percentages are always the same.
True False
8. The “inside basis” is defined as a partner’s basis in the partnership interest.
True False
9. The partnership reports each partner’s share of income to the partner in a single amount on Form 1099.
True False
10. Section 721 provides that, in general, no gain or loss is recognized by the partnership or the partner on
contribution of appreciated or depreciated property to a partnership in exchange for an interest in the
partnership.
True False
11. Ken and Lars formed the equal KL Partnership during the current year, with Ken contributing $100,000 in
cash and Lars contributing land (basis of $60,000, fair market value of $40,000) and equipment (basis of $0, fair
market value of $60,000). Lars recognizes a $40,000 gain on the contribution and his basis in his partnership
interest is $100,000.
True False
12. Morgan and Kristen formed an equal partnership on August 1 of the current year. Morgan contributed
$60,000 cash and land with a basis of $18,000 and a fair market value of $40,000. Kristen contributed
equipment with a basis of $42,000 and a value of $100,000. Kristen and Morgan each have a basis of $100,000
in their partnership interests.
True False
13. Section 721 provides that no gain or loss is recognized on a contribution of property to a partnership in
exchange for an interest in the partnership. An exception might apply if the taxpayer receives a cash distribution
from the partnership soon after the property contribution is made.
True False
14. George received a fully-vested 10% interest in partnership capital and a 20% interest in future partnership
profits in exchange for services rendered to the GHP, LLC (not a publicly-traded partnership interest). The
future profits of the partnership are subject to normal operating risks. George will report ordinary income equal
to the fair market value of the profits interest, but the capital interest will not be currently taxed to him.
True False
15. Laura is a real estate developer and owns property that is treated as inventory (not a capital asset) in her
business. She contributes a parcel of this land (basis of $15,000) to a partnership, also to be held as inventory.
The fair market value of the property is $12,000 at the contribution date. After three years, the partnership sells
the land for $10,000. The partnership will recognize a $5,000 ordinary loss on sale of the property.
True False
16. If the partnership properly makes an election for treatment of a specific tax item, the partner is bound by that
treatment.
True False
17. JLK Partnership incurred $6,000 of organizational costs and $50,000 of startup costs in 2013. JKL may
deduct $5,000 each of organizational and startup costs, and the remaining costs ($1,000 of organizational costs
and $45,000 of startup costs) may be amortized over 60 months.
True False
18. Syndication costs arise when partnership interests are being marketed to investors. These costs cannot be
amortized or deducted.
True False
19. Seven years ago, Paul purchased residential rental estate that he has been depreciating as MACRS property
over 27.5 years. This year, when his adjusted basis in the property was $250,000, Paul transferred the property
to the newly formed PLA LLC in exchange for a one-third interest in the LLC. PLA incurred $10,000 of
transfer taxes and fees related to the property. PLA must treat the $260,000 basis in the property, fees, and
expenses, as new MACRS property depreciable over 27.5 years.
True False
20. A partnership cannot use the cash method of accounting if one of the partners is a C corporation.
True False
21. ABC, LLC is equally-owned by three corporations. Two corporations have June 30 fiscal year ends, the
third is a calendar-year taxpayer. ABC will use the least aggregate deferral method to determine its taxable
year-end.
True False
22. PaulCo, DavidCo, and Sean form a partnership with cash contributions of $80,000, $50,000 and $30,000,
respectively, and agree to share profits and losses in the ratio of their original cash contributions. PaulCo uses a
January 31 fiscal year-end, while DavidCo and Sean use a November 30 and December 31 year-end,
respectively. The partnership must use the least aggregate deferral method to determine its year end.
True False
23. A partnership must provide any information to the partners that the partners would need to calculate
deductions not permitted at the partnership level, such as for oil and gas depletion or the corporate dividends
received deduction.
True False
24. Items that are not required to be shown on the partners’ Schedules K-1 include AMT adjustments and
preferences and taxes paid to foreign countries, as these calculations are made by the partnership.
True False
25. The JPM Partnership is a US-based manufacturing company. JPM calculates the domestic production
activities deduction (§ 199) and deducts that amount on its Form 1065.
True False
26. The amount of a partnership’s income and loss from operating activities is combined with separately stated
income and expenses to determine the partnership’s equivalent of “taxable income.” This amount is reconciled
to book income on the partnership’s Schedule M-1 or Schedule M-3.
True False
27. Partners’ capital accounts should be determined using the same method on Form 1065 Schedule L, Form
1065 Schedule M-2, and the Schedules K-1 prepared for the partners.
True False
28. A partnership’s allocations of income and deductions to the partners are required to be proportionate to the
partners’ percentage ownership of partnership capital in order to meet the substantial economic effect tests.
True False
29. Tom and William are equal partners in the TW Partnership. Just before TW liquidated, Tom’s capital
account balance was $50,000 and William’s capital account balance was $30,000. To meet the substantial
economic effect requirements, any liquidating cash distribution must be allocated in proportion to those ending
capital account balances.
True False
30. Blaine contributes property valued at $50,000 (basis of $40,000) in exchange for a 25% interest in the BIKE
Partnership. If the property is later sold for $70,000, gain of $15,000 will be allocated to Blaine.
True False
31. Emma’s basis in her BBDE LLC interest is $60,000 at the beginning of the tax year. Her allocable share of
LLC items are as follows: $20,000 of ordinary income, $2,000 tax-exempt interest income, and a $6,000
long-term capital gain. In addition, the LLC distributed $12,000 of cash to Emma during the year. Assuming the
LLC had no liabilities at the beginning or the end of the year, Emma’s ending basis in her LLC interest is
$76,000.
True False
32. Ashley purchased her partnership interest from Lindsey on the first day of the current year for $40,000 cash.
She received a $10,000 cash distribution from the partnership during the year, and her share of partnership
income is $15,000. Her share of partnership liabilities on the last day of the partnership year is $20,000.
Ashley’s outside basis for her partnership interest at the end of the year is $45,000.
True False
33. Julie and Kate form an equal partnership during the current year. Julie contributes cash of $160,000, and
Kate contributes property (adjusted basis of $90,000, fair market value of $260,000) subject to a nonrecourse
liability of $100,000. As a result of these transactions, Kate has a basis in her partnership interest of $40,000.
True False
34. Debt of a limited liability company is allocated among LLC members using the nonrecourse debt allocation
rules unless an LLC member has personally guaranteed the debt.
True False
35. The sum of the partners’ ending basis amounts on all Schedules K-1 equals the partners’ ending capital
account balance shown on the partnership’s Schedule L.
True False
36. If a partnership allocates losses to the partners, the partners must first apply the passive loss limitations, then
the basis limitation, and finally the at-risk limitations. If all three hurdles are met, the partner may deduct the
loss.
True False
37. Harry’s basis in his partnership interest was $10,000 at the beginning of the tax year. For the year, his share
of the partnership’s loss was $8,000, and he also received a distribution of $4,000. Harry can deduct an $8,000
loss, and he recognizes a gain of $2,000 on the distribution of cash in excess of his remaining basis.
True False
38. Nicholas, a 1/3 partner with a basis in the interest of $80,000 at the beginning of the year, received a
guaranteed payment in the current year of $50,000. Partnership income before consideration of the guaranteed
payment was $20,000. Nicholas reports a $10,000 ordinary loss from partnership operations, and the $50,000
guaranteed payment as ordinary income.
True False
39. William is a general partner in the WST partnership. During the current year, he receives a guaranteed
payment of $10,000 for services he provides to the partnership, and his distributive share of partnership income
is $30,000. William is required to pay self-employment tax on the $10,000 guaranteed payment, but not on his
distributive share of partnership income.
True False
40. Maria owns a 60% interest in the KLM Partnership. Four years ago her father gave her a parcel of land. The
gift basis of the land to Maria is $60,000. In the current year, Maria had still not figured out how to use the land
for her own personal or business use; consequently, she sold the land to the partnership for $50,000. The
partnership immediately started using the land as a parking lot for its employees. Maria may recognize her
$10,000 loss on the sale.
True False
41. One of the disadvantages of the partnership form is that the partner’s share of the partnership’s taxable
income is taxed to the partner, regardless of whether or not distributed.
True False
42. Which of the following entity owners cannot participate in management of the entity?
A. A general partner in a general partnership.
B. A member of a limited liability company.
C. A partner in a limited liability partnership.
D. A limited partner in a limited liability limited partnership.
E. None of the above.
43. Which one of the following statements regarding partnership taxation is incorrect?
A. A partnership is a taxable entity for Federal income tax purposes.
B. Partnership income is comprised of ordinary partnership income or loss and separately stated items.
C. A partnership is required to file a return with the IRS.
D. A partner’s profit-sharing percent may differ from the partner’s loss-sharing percent.
E. All of these statements are correct.
44. Which of the following is a correct definition of a concept related to partnership taxation?
A. The aggregate concept treats partners and partnerships as separate units and gives the partnership its own tax
“personality.”
B. A partner’s capital sharing ratio is defined as the percent of partnership assets (capital) that would be
allocated to the partner upon liquidation of the partnership.
C. The partnership’s outside basis is defined as the sum of each partner’s capital account balance.
D. A special allocation is defined as an amount that could differently affect the tax liabilities of two or more
partners.
E. None of these statements is correct.
45. A partnership will take a carryover basis in an asset it acquires when:
A. The partnership acquires the asset through a § 1031 like-kind exchange.
B. A partner owning 25% of partnership capital and profits sells the asset to the partnership.
C. The partnership leases the asset from a partner on a one-year lease.
D. The partnership acquires the asset from a partner as a contribution to partnership capital under § 721(a).
E. None of the above.
46. On January 1 of the current year, Anna and Jason form an equal partnership. Anna contributes $50,000 cash
and a parcel of land (adjusted basis of $100,000; fair market value of $150,000) in exchange for her interest in
the partnership. Jason contributes property (adjusted basis of $180,000; fair market value of $200,000) in
exchange for his partnership interest. Which of the following statements is true concerning the income tax
results of this partnership formation?
A. Jason recognizes a $20,000 gain on his property transfer.
B. Jason has a $200,000 tax basis for his partnership interest.
C. Anna has a $150,000 tax basis for her partnership interest.
D. The partnership has a $150,000 adjusted basis in the land contributed by Anna.
E. None of the statements is true.
47. Tim, Al, and Pat contributed assets to form the equal TAP Partnership. Tim contributed cash of $40,000 and
land with a basis of $80,000 (fair market value of $60,000). Al contributed cash of $60,000 and land with a
basis of $50,000 (fair market value of $40,000). Pat contributed cash of $60,000 and a fully depreciated
property ($0 basis) valued at $40,000. Which of the following tax treatments is not correct?
A. Tim’s basis in his partnership interest is $120,000.
B. Al realizes and recognizes a loss of $10,000.
C. Pat realizes a gain of $40,000 but recognizes $0 gain.
D. TAP has a basis of $80,000, $50,000, and $0 in the land and property (excluding cash) contributed by Tim,
Al, and Pat, respectively.
E. All of these statement are correct.
48. When property is contributed to a partnership in exchange for a capital and profits interest, when does the
partner’s holding period begin for the partnership interest?
A. The day after the contribution date.
B. The day the property was contributed.
C. The day the contributed property was purchased.
D. The day the partnership interest was acquired.
E. Either (or both) c. and d. may be true, depending upon the types of property contributed.
49. In which of the following independent situations would the transaction most likely be characterized as a
disguised sale?
A. Partner George contributes appreciated property to the GM Partnership, and three years later GM distributes
$100,000 proportionately to the partners.
B. Brianna contributes property with a basis of $20,000 and a fair market value of $50,000 to the BGB
Partnership in exchange for a 20% interest therein. The partnership agrees to distribute $20,000 to Brianna in
fifteen months, if partnership cash flows from operations exceed $100,000 at that time. The partnership does not
expect to produce operating cash flows of over $100,000 for at least five years.
C. Luis contributes appreciated property to the BLP Partnership. Thirty months later, he receives a distribution
from the partnership of $15,000 cash. None of the other partners received a distribution. There was no
agreement that BLP would make the distribution, and Luis would have made the contribution whether or not the
partnership made the distribution.
D. None of the above transactions will be treated as a disguised sale.
E. a., b., and c. are all treated as disguised sales.
50. Tara and Robert formed the TR Partnership four years ago. Because they decided the company needed some
expertise in multimedia presentations, they offered Katie a 1/3 interest in partnership capital if she would come
to work for the partnership. She will also receive a 25% interest in future partnership profits. On July 1 of the
current year, the unrestricted partnership capital interest (fair market value of $25,000) was transferred to Katie.
How should Katie treat the receipt of the partnership interest in the current year?
A. Nontaxable.
B. $25,000 ordinary income.
C. $25,000 short-term capital gain.
D. $25,000 long-term capital gain.
E. None of the above.
51. Which of the following would be currently taxable as ordinary income to the service partner if received in
exchange for services performed for the partnership? (In all cases, assume the interest is not sold within two
years after the time it is granted to the service partner.)
A. A 10% interest in the capital of the partnership that will vest in 3 years.
B. A 20% interest in the future profits of the partnership received in exchange for future services to be
performed for the partnership.
C. A 25% interest in the capital of the partnership where there are no restrictions on transferability of the
interest.
D. A 30% interest in ongoing profits of the partnership where the partnership is not a publicly-traded
partnership and the income stream is not assured.
E. All of the above.
52. Which of the following is an election or calculation made by the partner rather than the partnership?
A. Calculation of a § 199 deduction amount.
B. Whether to capitalize, amortize, or expense research and experimental costs.
C. The partnership’s overall accounting method.
D. Whether to claim a § 179 deduction related to property acquired by the partnership.
E. All of the above elections are made by the partnership.
53. TEC Partners was formed during the current tax year. It incurred $10,000 of organizational expenses,
$80,000 of startup expenses, and $5,000 of transfer taxes to retitle property contributed by a partner. The
property had been held as MACRS property for ten years by the contributing partner, and had an adjusted basis
to the partner of $300,000 and fair market value of $400,000. Which of the following statements is correct
regarding these items?
A. TEC treats the contributed property as a new MACRS asset placed in service on the date the property title is
transferred.
B. TEC must amortize the $10,000 of organizational expenses over 180 months.
C. TEC’s startup expenses are amortized over 60 months.
D. TEC must capitalize the transfer tax and treat if as a new asset placed in service on the date the property is
contributed.
E. None of the above statements are true.
54. Which of the following statements is always correct regarding assets acquired by a newly formed
partnership? If a partner contributes:
A. Depreciable property: the partnership treats the property as newly acquired depreciable property, and may
claim a § 179 deduction.
B. Unrealized (cash-basis) receivables: the partnership will report a capital gain when the receivable is
collected.
C. Inventory (in the partner’s hands): the partnership reports ordinary income if the property is held as a capital
asset and sold within five years of the contribution date.
D. Land valued at less than its basis: the partnership reports a § 1231 loss if the property is sold at a loss.
E. None of these statements is correct.
55. Which of the following statements is always true regarding accounting methods available to a partnership?
A. If a partnership is a tax shelter, it can use the cash method of accounting.
B. If a non-tax-shelter partnership had “average annual gross receipts” of less than $5 million in all prior years,
it can use the cash method.
C. If a partnership has a partner that is a personal service corporation, it cannot use the cash method.
D. If a partnership has a partner that is a C corporation, it cannot use the cash method.
E. All of the above statements are false.
56. Fern, Inc., Ivy, Inc., and Jeremy formed a general partnership. Fern owns a 50% interest and Ivy and Jeremy
each own 25% interests. Fern, Inc. files its tax return on an October 31 year-end; Ivy, Inc., files with a July 31
year-end, and Jeremy is a calendar year taxpayer. Which of the following statements is true regarding the
taxable year the partnership can choose?
A. The partnership must choose the calendar year because it has no principal partners.
B. The partnership must choose an October year-end because Fern, Inc., is a principal partner.
C. The partnership can request permission from the IRS to use a March 31 fiscal year under § 444.
D. The partnership must use the “least aggregate deferral” method to determine its taxable year.
E. None of the above.
57. In the current year, the POD Partnership received revenues of $200,000 and paid the following amounts:
$50,000 in rent and utilities, and $20,000 as a distribution to partner Olivia. In addition, the partnership earned
$6,000 of long-term capital gains during the year. Partner Donald owns a 50% interest in the partnership. How
much income must Donald report for the tax year?
A. $68,000 ordinary income.
B. $78,000 ordinary income.
C. $65,000 ordinary income; $3,000 of long-term capital gains.
D. $75,000 ordinary income; $3,000 of long-term capital gains.
E. None of the above.
58. Kristie is a 30% partner in the KKM Partnership. During the current year, KKM reported gross receipts of
$280,000 and a charitable contribution of $30,000. The partnership paid office expenses of $80,000. In addition,
KKM distributed $20,000 each to partners Kaylyn and Megan, and the partnership paid partner Kaylyn $20,000
for administrative services. Kristie reports the following income from KKM during the current tax year:
A. $54,000 ordinary income; $9,000 charitable contribution.
B. $60,000 ordinary income; $9,000 charitable contribution.
C. $36,000 ordinary income.
D. $54,000 ordinary income.
E. None of the above.
59. Which one of the following is not shown on the partnership’s Schedule K on Page 4 of Form 1065?
A. The partnership’s self-employment income.
B. The partnership’s separately stated income and deductions.
C. The partnership’s tax preference and adjustment items.
D. The partnership’s net operating loss carryforward.
E. All of the above.
60. On a partnership’s Form 1065, which of the following statements is not true?
A. The partnership reconciles its net income (including separately stated items) to book income on Schedule
M-1 or M-3.
B. The partnership balance sheet on Schedule L is generally presented on a financial (book) basis.
C. All partnership income and expense items are reported on Form 1065, page 1.
D. The partnership’s equivalent of taxable income is reported in the “Analysis of Income (Loss).”
E. None of the above statements are true.
61. ABC LLC reported the following items on the LLC’s Schedule K: ordinary income, $100,000; interest
income, $3,000; long-term capital loss, ($4,000); charitable contributions, $1,000; post-1986 depreciation
adjustment, $10,000; and cash distributions to partners, $50,000. How much will ABC show as net income
(loss) on its Analysis of Income (Loss)?
A. $68,000.
B. $78,000.
C. $95,000.
D. $98,000.
E. $102,000.
62. Which of the following statements is not a requirement of the substantial economic effect test?
A. Income, gains, losses, and deductions must be allocated to the partners in accordance with their capital
contributions.
B. An allocation of income must increase the partner’s capital account balance, and an allocation of deduction
must decrease the partner’s capital account balance.
C. A partner with a negative capital account balance must “restore” that capital account, generally by
contributing cash to the partnership.
D. On liquidation of the partner’s interest in the partnership, the partner must receive assets that have a fair
market value equal to that partner’s (positive) capital account balance.
E. All of the above statements are requirements of the substantial economic effect test.
63. Brooke and John formed a partnership. Brooke received a 40% interest in partnership capital and profits in
exchange for contributing land (basis of $30,000 and fair market value of $120,000). John received a 60%
interest in partnership capital and profits in exchange for contributing $180,000 of cash. Three years after the
contribution date, the land contributed by Brooke is sold by the partnership to a third party for $150,000. How
much taxable gain will Brooke recognize from the sale?
A. $102,000.
B. $90,000.
C. $48,000.
D. $36,000.
E. $0.
64. Mark and Addison formed a partnership. Mark received a 25% interest in partnership capital and profits in
exchange for land with a basis of $40,000 and a fair market value of $60,000. Addison received a 75% interest
in partnership capital and profits in exchange for $180,000 of cash. Three years after the contribution date, the
land contributed by Mark is sold by the partnership to a third party for $76,000. How much taxable gain will
Mark recognize from the sale?
A. $0.
B. $9,000.
C. $24,000.
D. $36,000.
E. None of the above.
65. Ryan is a 25% partner in the ROCC Partnership. At the beginning of the tax year, Ryan’s basis in the
partnership interest was $90,000, including his share of partnership liabilities. During the current year, ROCC
reported net ordinary income of $100,000. In addition, ROCC distributed $10,000 to each of the partners
($40,000 total). At the end of the year, Ryan’s share of partnership liabilities increased by $10,000. Ryan’s basis
in the partnership interest at the end of the year is:
A. $90,000.
B. $100,000.
C. $115,000.
D. $125,000.
E. None of the above.
66. Allison is a 40% partner in the BAM Partnership. At the beginning of the tax year, Allison’s basis in the
partnership interest was $100,000, including her share of partnership liabilities. During the current year, BAM
reported an ordinary loss of $60,000. In addition, BAM distributed $8,000 to Allison and paid partner Brian a
$20,000 consulting fee (neither of these amounts was deducted in determining the $60,000 loss from
operations). At the end of the year, Allison’s share of partnership liabilities decreased by $10,000. Assuming
loss limitation rules do not apply, Allison’s basis in the partnership interest at the end of the year is:
A. $2,000.
B. $50,000.
C. $70,000.
D. $100,000.
E. None of the above.
67. Binita contributed property with a basis of $40,000 and a value of $50,000 to the BE Partnership in
exchange for a 20% interest in partnership capital and profits. During the first year of partnership operations,
BE had net taxable income of $30,000 and tax-exempt interest income of $10,000. The partnership distributed
$10,000 cash to Binita. Binita’s adjusted basis (outside basis) for her partnership interest at year-end is:
A. $36,000.
B. $38,000.
C. $60,000.
D. $70,000.
E. None of the above.
68. At the beginning of the year, Heather’s “tax basis” capital account balance in the HEP Partnership was
$85,000. During the tax year, Heather contributed property with a basis of $6,000 and a fair market value of
$10,000. Her share of the partnership’s ordinary income and separately stated income and deduction items was
$40,000. At the end of the year, the partnership distributed $15,000 of cash to Heather. Also, the partnership
allocated $12,000 of recourse debt and $10,000 of nonrecourse debt to Heather. What is Heather’s ending
capital account balance determined using the “tax basis” method?
A. $116,000.
B. $120,000.
C. $126,000.
D. $128,000.
E. $138,000.
69. Misty and John formed the MJ Partnership. Misty contributed $50,000 of cash in exchange for her 50%
interest in the partnership capital and profits. During the first year of partnership operations, the following
events occurred: the partnership had a net taxable income of $20,000; Misty received a distribution of $12,000
cash from the partnership; and Misty had a 50% share in the partnership’s $60,000 of recourse liabilities on the
last day of the partnership year. Misty’s adjusted basis for her partnership interest at year end is:
A. $48,000.
B. $60,000.
C. $78,000.
D. $88,000.
E. $90,000.
70. Which of the following statements is correct regarding the manner in which partnership liabilities are
reflected in the partners’ bases in their partnership interests?
A. Nonrecourse debt is allocated to the partners according to their loss-sharing ratios.
B. Recourse debt is allocated to the partners to the extent of the partnership’s minimum gain in the property.
C. An increase in partnership debts results in a decrease in the partners’ bases in the partnership interest.
D. A decrease in partnership debt is treated as a distribution from the partnership to the partner and reduces the
partner’s basis in the partnership interest.
E. Partnership debt is not reflected in the partners’ bases in their partnership interests.
71. Alicia and Barry form the AB Partnership at the start of the current year with a land contribution by Barry
and a cash contribution by Alicia. Barry’s contributed property is subject to a recourse mortgage assumed by the
partnership. Barry has an 80% interest in AB’s profits and losses. The land has been held by Barry for the past 6
years as an investment. It will be used by AB as an operating asset in its parking lot business. Which of the
following statements is correct?
A. Immediately after formation, Alicia’s basis in the partnership equals the cash contributed by Alicia.
B. Immediately after formation, Alicia’s basis in the partnership equals the cash she contributed plus her share
of the recourse debt contributed by Barry.
C. Because the debt is recourse, the constructive liquidation scenario is not applicable for determining the
allocation of debt to the partners.
D. AB’s basis in the land contributed by Barry equals Barry’s basis in the land immediately before the
contribution date, less the amount of the recourse debt assumed by the partnership.
E. None of the above.
72. Sharon contributed property to the newly formed QRST Partnership. The property had a $100,000 adjusted
basis to Sharon and a $160,000 fair market value on the contribution date. The property was also encumbered
by a $120,000 nonrecourse debt, which was transferred to the partnership on that date. Another partner,
Rochelle, shares 30% of the partnership income, gain, loss, deduction, and credit. Under IRS regulations,
Rochelle’s share of the nonrecourse debt for basis purposes is:
A. $20,000.
B. $30,000.
C. $36,000.
D. $100,000.
E. $120,000.
73. During the current tax year, Jordan and Whitney each contributed $50,000 to form the J&W LLC. Each
member has a 50% interest in LLC capital, profits, and losses, except that depreciation expense is allocated 40%
to Jordan and 60% to Whitney. During the first year, the LLC reported income (before depreciation expense) of
$20,000 and had depreciation expense of $10,000. The LLC incurred recourse debt (that was personally
guaranteed by both of the LLC members) of $60,000. Partnership assets are $170,000 at the end of the year.
Under the constructive liquidation scenario, how is the recourse debt allocated to Jordan and Whitney?
A. The recourse debt is shared equally ($30,000 each) by Jordan and Whitney.
B. The recourse debt is allocated $36,000 to Whitney and $24,000 to Jordan.
C. The recourse debt is allocated $31,000 to Whitney and $29,000 to Jordan.
D. The recourse debt is allocated $29,000 to Whitney and $31,000 to Jordan.
E. The recourse debt is allocated $24,000 to Whitney and $36,000 to Jordan.
74. Which of the following is not a specific adjustment to the partners’ basis in the partnership interest?
A. Increased by contributions the partner made to the partnership.
B. Decreased by the amount of guaranteed payments shown on the partner’s Schedule K-1.
C. Increased by the partner’s share of tax-exempt income.
D. Decreased by any decrease in the partner’s share of partnership liabilities.
E. Increased by the partner’s share of separately stated income items.
75. Rebecca is a limited partner in the RST Partnership, which is not publicly traded. Her allocable share of
RST’s passive ordinary losses from a nonrealty activity for the current year is ($60,000). Rebecca has a $40,000
adjusted basis (outside basis) for her interest in RST (before deduction of any of the passive losses). Her amount
“at risk” under § 465 is $30,000 (before deduction of any of the passive losses). She also has $25,000 of passive
income from other sources. How much of her ($60,000) allocable loss can Rebecca deduct on her current year’s
tax return?
A. $25,000.
B. $30,000.
C. $40,000.
D. $60,000.
E. None of the above.
76. At the beginning of the tax year, Zach’s basis for his partnership interest and his amount at risk in the
partnership was $30,000. His share of partnership items for the year consisted of tax-exempt interest income of
$2,000 and an ordinary loss of $44,000. He also received a distribution from the partnership of $20,000 cash
during the year. For the tax year, Zach will report:
A. A nontaxable distribution of $20,000, an ordinary loss of $10,000, and a suspended loss carryforward of
$34,000.
B. An ordinary loss of $32,000, a suspended loss carryforward of $12,000, and a taxable distribution of
$20,000.
C. A nontaxable distribution of $20,000, an ordinary loss of $12,000, and a suspended loss carryforward of
$32,000.
D. An ordinary loss of $44,000 and a nontaxable distribution of $20,000.
77. Paul sells one parcel of land (basis of $100,000) for its fair market value of $160,000 to a partnership in
which he owns a 60% capital interest. Paul held the land for investment purposes. The partnership is in the real
estate development business, and will build residential housing (for sale to customers) on the land. Paul will
recognize:
A. $0 gain or loss.
B. $36,000 ordinary income.
C. $36,000 capital gain.
D. $60,000 ordinary income.
E. $60,000 capital gain.
78. Molly is a 30% partner in the MAP Partnership. During the current tax year, the partnership reported
ordinary income of $200,000 before payment of guaranteed payments and distributions to partners. The
partnership made an ordinary cash distribution of $20,000 to Molly, and paid guaranteed payments to partners
Molly, Amber, and Pat of $20,000 each ($60,000 total). How much will Molly’s adjusted gross income increase
as a result of the above items?
A. $42,000.
B. $60,000.
C. $62,000.
D. $80,000.
E. None of the above.
79. Stephanie is a calendar year cash basis taxpayer. She owns a 50% profit and loss interest in a cash basis
partnership with a September 30 year-end. The partnership’s operating income (after deducting guaranteed
payments) was $120,000 ($10,000 per month) and $144,000 ($12,000 per month), respectively, for the
partnership tax years ended September 30, 2013 and 2014. The partnership paid guaranteed payments to
Stephanie of $2,000 and $3,000 per month during the fiscal years ended September 30, 2013 and 2014. How
much will Stephanie’s adjusted gross income be increased by these partnership items for her tax year ended
December 31, 2013?
A. $60,000.
B. $72,000.
C. $84,000.
D. $90,000.
E. $108,000.
80. Samuel is the managing general partner of STU, in which he owns a 25% interest. For the year, STU
reported ordinary income of $400,000 (after deducting all guaranteed payments). In addition, the LLC reported
interest income of $10,000. Samuel received a guaranteed payment of $120,000 for services he performed for
STU. How much income from self-employment did Samuel earn from STU?
A. $100,000.
B. $120,000.
C. $220,000.
D. $222,000.
E. None of the above.
81. Which of the following is not a correct statement regarding the advantage of the partnership entity form
over the subchapter C corporate form?
A. A partnership typically has easier administrative and filing requirements than does a C corporation.
B. Partnership income is subject to a single level of taxation; corporate income is double taxed.
C. Partnerships may specially allocate income and expenses among the partners, provided the substantial
economic effect requirements are met; corporate dividends must be proportionate to shareholdings.
D. Partners in a general partnership have less personal liability for entity claims than shareholders of a C
corporation.
E. All of the above are advantages of partnership taxation.
82. Match each of the following statements with the terms below that provide the best definition.
1. Check the box
regulations
2. Syndication costs
3. Limited partnership
4. Disguised sale
5. Aggregate concept
6. Substituted
7. General partnership
8. Qualified
nonrecourse debt
9. Limited liability
company
10. Carryover
11. Separately stated
item
12. Profits interest
13. Entity concept
14. Limited liability
partnership
Must have at least one general and one limited
partner.
Allows many unincorporated entities to select
their Federal tax status.
Partner’s percentage allocation of current
operating income.
Organizational choice of many large accounting
firms.
Theory treating the partnership as a collection of
taxpayers joined in an agency relationship.
Partner’s basis in partnership interest after
tax-free contribution of asset to partnership.
Owners are “members.”
No correct match provided.
Brokerage and registration fees incurred for
promoting and marketing partnership interests.
Transfer of asset to partnership followed by
immediate distribution of cash to partner.
Might affect any two partners’ tax liabilities in
different ways.
Partnership’s basis in asset after tax-free
contribution of asset to partnership.
Theory treating the partner and partnership as
separate economic units.
All partners are jointly and severally liable for
entity debts.
____
____
____
____
____
____
____
____
____
____
____
____
____
____
83. George and James are forming the GJ Partnership. George contributes $600,000 cash and James contributes
nondepreciable property with an adjusted basis of $400,000 and a fair market value of $750,000. The property
is subject to a $150,000 liability, which is also transferred into the partnership and is shared equally by the
partners for basis purposes. George and James share in all partnership profits equally except for any
precontribution gain, which must be allocated according to the statutory rules for built-in gain allocations.
a.
What is James’s adjusted tax basis for his partnership interest immediately after the partnership is formed?
b.
What is the partnership’s adjusted basis for the property contributed by James?
c.
If the partnership sells the property contributed by James for $800,000, how is the tax gain allocated between the partners?
84. Palmer contributes property with a fair market value of $4,000,000 and an adjusted basis of $3,000,000 to
AP Partnership. Palmer shares in $1,000,000 of partnership debt under the liability sharing rules, giving him an
initial adjusted basis for his partnership interest of $4,000,000. One month after the contribution, Palmer
receives a cash distribution from the partnership of $2,000,000. Palmer would not have contributed the property
if the partnership had not contractually obligated itself to make the distribution. Assume Palmer’s share of
partnership liabilities will not change as a result of this distribution.
a.
Under the IRS’s likely treatment of this transaction, what is the amount of gain or loss that Palmer will recognize because of the
$2,000,000 cash distribution?
b.
What is the partnership’s basis for the property after the distribution?
c.
If Palmer is unhappy with this result, can you suggest a possible alternative that may provide him with a better answer?
85. During the current year, MAC Partnership reported the following items of receipts and expenditures:
$600,000 sales, $80,000 utilities and rent, $200,000 salaries to employees, $20,000 guaranteed payment to
partner Antonio, investment interest income of $4,000, a charitable contribution of $8,000, and a distribution of
$30,000 to partner Carl. Antonio is a 25% general partner. Based on this information, what items will be
reflected on Antonio’s Schedule K-1?
86. The LN partnership reported the following items of income and deduction during the current tax year:
revenues, $300,000; cost of goods sold, $180,000; tax-exempt interest income, $2,000; salaries to employees,
$80,000; and long-term capital gain, $10,000. In addition, the partnership distributed $20,000 of cash to 50%
partner Nina and $10,000 of cash to 50% partner Len. What is Nina’s share of ordinary partnership income and
separately stated items?
87. Carli contributes land to the newly formed CD Partnership in exchange for a 30% interest. The land has an
adjusted basis and fair market value of $300,000 and is subject to a liability of $100,000, which the partnership
assumes. None of this liability is repaid at year-end. At the end of the year, the partnership has trade accounts
payable of $20,000. Assume all liabilities are allocated proportionately to the partners. Total partnership income
for the year is $400,000. What is Carli’s basis in her partnership interest at the end of the year?
88. An examination of the RB Partnership’s tax books provides the following information for the current year:
Operating (ordinary) income before guaranteed payments
Long-term capital gain
Guaranteed payment to Rachel for services
Cash distributions to each partner
Interest on Colorado state bonds (exempt interest income)
Charitable contributions made by partnership
Decrease in partnership liabilities from 1/1-12/31
$300,000
6,000
30,000
20,000
2,000
10,000
(20,000)
Rachel is a 30% general partner in partnership capital, profits, and losses. Assume the adjusted basis of her partnership interest is $60,000 at the
beginning of the year, and she shares in 30% of the partnership’s liabilities for basis purposes.
a.
What is Rachel’s adjusted basis for the partnership interest at the end of the year?
b.
How much income must Rachel report on her tax return for the current year? What is the character of income?
89. Katherine invested $80,000 this year to purchase a 30% interest in the KLM Partnership. The partnership
reported $200,000 of net income from operations, a $2,000 short-term capital loss, and a $10,000 charitable
contribution. In addition, the partnership distributed $20,000 to Katherine and $10,000 each to partners Lauren
and Missy. Assuming the partnership has no beginning or ending liabilities, what is Katherine’s basis in her
partnership interest at the end of the year?
90. Sarah contributed fully depreciated ($0 basis) property valued at $50,000 to the RSTU Partnership in
exchange for a 25% interest in partnership capital and profits. During the first year of partnership operations,
RSTU had net taxable income of $200,000 and tax-exempt income of $4,000. The partnership distributed
$10,000 cash to Sarah. Her share of partnership recourse liabilities on the last day of the partnership year was
$20,000. What is Sarah’s adjusted basis (outside basis) for her partnership interest at the end of the tax year?
91. In the current year, the DOE LLC received revenues of $200,000 and paid the following amounts: $50,000
in rent and utilities, a $40,000 guaranteed payment to 50% member Dave, $10,000 to member Ethan for
consulting services, and $10,000 as a distribution to member Olivia. In addition, the LLC earned $2,000 of
tax-exempt interest income during the year. Dave is the managing member of the LLC. Dave’s basis in his LLC
interest was $50,000 at the beginning of the year, and includes a $12,000 share of LLC liabilities. At the end of
the year, his share of the LLC’s liabilities was $20,000.
a.
How much income must Dave report for the tax year and what is the character of the income?
b.
What is Dave’s basis in his LLC interest at the end of the tax year?
c.
On what income will Dave’s self-employment tax be calculated?
92. Sharon and Sue are equal partners in the S&S Partnership. On January 1 of the current year, each partner’s
adjusted basis in S&S was $80,000 (including each partner’s $20,000 share of the partnership’s $40,000 of
liabilities). During the current year, S&S repaid $30,000 of the debt and borrowed $20,000 for which Sharon
and Sue are equally liable. In the current year ended December 31, S&S also sustained a net operating loss of
$40,000 and earned $10,000 of interest income from investments. If liabilities are shared equally by the
partners, on January 1 of the next year how much is each partner’s basis in her interest in S&S?
93. In the current year, the CAR Partnership received revenues of $400,000 and paid the following amounts:
$160,000 in rent, utilities, and salaries; a $40,000 guaranteed payment to partner Ryan; $20,000 to partner Amy
for consulting services; and a $40,000 distribution to 25% partner Cameron. In addition, the partnership realized
a $12,000 net long-term capital gain. Cameron’s basis in his partnership interest was $60,000 at the beginning
of the year, and included his $25,000 share of partnership liabilities. At the end of the year, his share of
partnership liabilities was $15,000.
a.
How much income must Cameron report for the tax year?
b.
What is Cameron’s basis in the partnership interest at the end of the year?
94. In the current year, Derek formed an equal partnership with Cody. Derek contributed land with an adjusted
basis of $110,000 and a fair market value of $200,000. Derek also contributed $50,000 cash to the partnership.
Cody contributed land with an adjusted basis of $80,000 and a fair market value of $230,000. The land
contributed by Derek was encumbered by a $60,000 nonrecourse debt. The land contributed by Cody was
encumbered by $40,000 of nonrecourse debt. Assume the partners share debt equally. Immediately after the
formation, what is the basis of Cody’s partnership interest?
95. Morgan is a 50% managing member in the calendar year, cash basis MKK LLC. The LLC received
$150,000 income from services and paid the following other amounts:
Rent expense
Salary expense to employees
Payment to Morgan for services, per the operating agreement
Distributions to partners, Kristin and Katie
Payment to 30% cash basis partner Katie for tax and accounting services
$10,000
40,000
30,000
12,000
10,000
How much will Morgan’s adjusted gross income increase as a result of the above items? What amount will be included in Morgan’s self-employment
tax calculation?
96. The MOP Partnership is involved in leasing heavy equipment under long-term leases of five years or more.
Patricia has an adjusted basis for her partnership interest on January 1 of the current year of $600,000,
consisting of the following:
Capital account
Share of partnership recourse debt
Share of partnership nonrecourse debt
$350,000
50,000
200,000
$600,000
During the year, the partnership has an operating loss of $1.2 million and distributes $60,000 of cash to Patricia. Partnership liabilities were the same
at the end of the tax year, and the nonrecourse debt is not “qualified nonrecourse debt.” If she owns a 60% share of partnership profits, capital, and
losses, and is a material participant in the partnership, how much of her share of the operating loss can Patricia deduct? What Code provisions could
cause a suspension of the loss? How would your answer change if MOP were an LLC and Patricia had not personally guaranteed any of the debt?
97. Cassandra is a 10% limited partner in C&C, Ltd. Her basis in the interest is $60,000 before loss allocations,
including her $30,000 share of the partnership’s nonrecourse debt. (This debt is not qualified nonrecourse
financing.) Cassandra is also a 10% limited partner in MNOP, in which her basis is $30,000. Cassandra is
allocated an $80,000 loss from C&C, and $20,000 of income from MNOP. How much of the loss from C&C
may Cassandra deduct? Under what Code provisions are the remaining losses suspended?
98. Jeordie and Kendis created the JK Partnership by contributing $100,000 each. The $200,000 cash was used
by the partnership to acquire a depreciable asset. The partnership agreement provides that the partners’ capital
accounts will be maintained in accordance with Reg. § 1.704-1(b) (the “economic effect” Regulations) and that
any partner with a deficit capital account will be required to restore that capital account when the partner’s
interest is liquidated. The partnership agreement provides that MACRS will be allocated 20% to Jeordie and
80% to Kendis. All other items of partnership income, gain, loss, deduction, and credit will be allocated equally
between the partners. In the first year, MACRS is $40,000 and no other operating transactions occur. The
property is sold at the end of the year for $160,000 and the partnership is liquidated immediately thereafter.
To satisfy the economic effect test, how much of the $160,000 cash (from the sale) is allocated each to Jeordie
and Kendis?
99. Allison and Taylor form a partnership by each making contributions of $90,000 cash to partnership capital.
The partnership purchases an asset for $600,000, using the cash and financing the rest with a $420,000 recourse
note. The partners expect the partnership to have losses for the first three years of operations and profits
thereafter. Allison is allocated 75% of partnership losses until the date when the total partnership profits
exceed total partnership losses. After that date, the profits and losses are shared equally between the two
partners. How will the recourse debt be shared between the partners for basis purposes immediately after the
property is acquired?
100. On the formation of a partnership, when might a “disguised sale” occur? How can this treatment be
avoided?
101. Your client owns a parcel of land that has depreciated in value. He wants to know if there is a way he can
contribute the property to his partnership, have the partnership sell the property, and convert the existing capital
loss into an ordinary loss. He also wants to know if part of the loss would be allocated to his other partners.
What is your reaction?
102. What are “syndication costs” and how are they treated for tax purposes?
103. Harry and Sally are considering forming a partnership. Both taxpayers use the calendar year and are cash
basis taxpayers. The partnership will not be a tax shelter. The partners are uncertain as to whether the
partnership should use the cash or accrual method of accounting. Also, the idea of a tax deferral in the first year
of operations has led them to consider using a June 30 fiscal year-end for the partnership.
As their tax adviser, identify the issues that must be considered in selecting an accounting method and tax year
for the partnership.
104. The MOG Partnership reports ordinary income of $60,000, long-term capital gain of $12,000, and
tax-exempt income of $12,000. The partnership agreement provides that Molly will receive all long-term capital
gains and George will receive all tax-exempt interest income. Their allocation of ordinary income will be
reduced accordingly, and Olivia will be allocated a proportionately greater share of ordinary income. (In other
words, each partner will receive allocations totaling 1/3 of the total $84,000 of partnership income.) This
allocation was agreed upon because Molly and George are in a high marginal tax bracket and Olivia is in a low
marginal tax bracket.
a.
Describe the elements that must be included in a partnership agreement in order for an allocation to have "economic effect."
b.
Discuss whether or not the MOG allocation would be permitted and provide your reasoning.
105. On a corporate Form 1120, Schedule M-1 (or M-3) is used to reconcile book and tax income, and Schedule
M-2 reconciles retained earnings to the amounts shown on Schedule L. How are these reconciliations
accomplished on a partnership return? What additional information must be provided?
106. If a partnership receives tax-exempt income, this should not affect its partners’ basis in their partnership
interest. Do you agree with this statement? Explain.
107. What is the difference between a partner’s basis in the partnership interest and a partner’s capital account?
What are the purposes of these two amounts? Why are these amounts typically different?
CHAPTER 10--PARTNERSHIPS: FORMATION, OPERATION,
AND BASIS Key
1. A partnership is an association formed by two or more taxpayers (who may be any type of entity) to carry on
a trade or business.
TRUE
2. In a limited liability company, all members are protected from all debts of the partnership unless they
personally guaranteed the debt.
TRUE
3. A limited partnership offers all partners protection from claims by the LP’s creditors.
FALSE
4. The primary purpose of the partnership agreement is to document the various tax elections made by the
partners regarding depreciation methods, treatment of research and experimental costs, calculation of the § 199
deduction, and the § 754 election.
FALSE
5. The taxable income of a partnership flows through to the partners, who report the income on their tax
returns.
TRUE
6. An example of the “aggregate concept” underlying partnership taxation is the fact that the partners (rather
than the partnership) pay tax on partnership income.
TRUE
7. Each partner’s profit-sharing, loss-sharing, and capital-sharing ownership percentages are always the same.
FALSE
8. The “inside basis” is defined as a partner’s basis in the partnership interest.
FALSE
9. The partnership reports each partner’s share of income to the partner in a single amount on Form 1099.
FALSE
10. Section 721 provides that, in general, no gain or loss is recognized by the partnership or the partner on
contribution of appreciated or depreciated property to a partnership in exchange for an interest in the
partnership.
TRUE
11. Ken and Lars formed the equal KL Partnership during the current year, with Ken contributing $100,000 in
cash and Lars contributing land (basis of $60,000, fair market value of $40,000) and equipment (basis of $0, fair
market value of $60,000). Lars recognizes a $40,000 gain on the contribution and his basis in his partnership
interest is $100,000.
FALSE
12. Morgan and Kristen formed an equal partnership on August 1 of the current year. Morgan contributed
$60,000 cash and land with a basis of $18,000 and a fair market value of $40,000. Kristen contributed
equipment with a basis of $42,000 and a value of $100,000. Kristen and Morgan each have a basis of $100,000
in their partnership interests.
FALSE
13. Section 721 provides that no gain or loss is recognized on a contribution of property to a partnership in
exchange for an interest in the partnership. An exception might apply if the taxpayer receives a cash distribution
from the partnership soon after the property contribution is made.
TRUE
14. George received a fully-vested 10% interest in partnership capital and a 20% interest in future partnership
profits in exchange for services rendered to the GHP, LLC (not a publicly-traded partnership interest). The
future profits of the partnership are subject to normal operating risks. George will report ordinary income equal
to the fair market value of the profits interest, but the capital interest will not be currently taxed to him.
FALSE
15. Laura is a real estate developer and owns property that is treated as inventory (not a capital asset) in her
business. She contributes a parcel of this land (basis of $15,000) to a partnership, also to be held as inventory.
The fair market value of the property is $12,000 at the contribution date. After three years, the partnership sells
the land for $10,000. The partnership will recognize a $5,000 ordinary loss on sale of the property.
TRUE
16. If the partnership properly makes an election for treatment of a specific tax item, the partner is bound by that
treatment.
TRUE
17. JLK Partnership incurred $6,000 of organizational costs and $50,000 of startup costs in 2013. JKL may
deduct $5,000 each of organizational and startup costs, and the remaining costs ($1,000 of organizational costs
and $45,000 of startup costs) may be amortized over 60 months.
FALSE
18. Syndication costs arise when partnership interests are being marketed to investors. These costs cannot be
amortized or deducted.
TRUE
19. Seven years ago, Paul purchased residential rental estate that he has been depreciating as MACRS property
over 27.5 years. This year, when his adjusted basis in the property was $250,000, Paul transferred the property
to the newly formed PLA LLC in exchange for a one-third interest in the LLC. PLA incurred $10,000 of
transfer taxes and fees related to the property. PLA must treat the $260,000 basis in the property, fees, and
expenses, as new MACRS property depreciable over 27.5 years.
FALSE
20. A partnership cannot use the cash method of accounting if one of the partners is a C corporation.
FALSE
21. ABC, LLC is equally-owned by three corporations. Two corporations have June 30 fiscal year ends, the
third is a calendar-year taxpayer. ABC will use the least aggregate deferral method to determine its taxable
year-end.
FALSE
22. PaulCo, DavidCo, and Sean form a partnership with cash contributions of $80,000, $50,000 and $30,000,
respectively, and agree to share profits and losses in the ratio of their original cash contributions. PaulCo uses a
January 31 fiscal year-end, while DavidCo and Sean use a November 30 and December 31 year-end,
respectively. The partnership must use the least aggregate deferral method to determine its year end.
TRUE
23. A partnership must provide any information to the partners that the partners would need to calculate
deductions not permitted at the partnership level, such as for oil and gas depletion or the corporate dividends
received deduction.
TRUE
24. Items that are not required to be shown on the partners’ Schedules K-1 include AMT adjustments and
preferences and taxes paid to foreign countries, as these calculations are made by the partnership.
FALSE
25. The JPM Partnership is a US-based manufacturing company. JPM calculates the domestic production
activities deduction (§ 199) and deducts that amount on its Form 1065.
FALSE
26. The amount of a partnership’s income and loss from operating activities is combined with separately stated
income and expenses to determine the partnership’s equivalent of “taxable income.” This amount is reconciled
to book income on the partnership’s Schedule M-1 or Schedule M-3.
TRUE
27. Partners’ capital accounts should be determined using the same method on Form 1065 Schedule L, Form
1065 Schedule M-2, and the Schedules K-1 prepared for the partners.
FALSE
28. A partnership’s allocations of income and deductions to the partners are required to be proportionate to the
partners’ percentage ownership of partnership capital in order to meet the substantial economic effect tests.
FALSE
29. Tom and William are equal partners in the TW Partnership. Just before TW liquidated, Tom’s capital
account balance was $50,000 and William’s capital account balance was $30,000. To meet the substantial
economic effect requirements, any liquidating cash distribution must be allocated in proportion to those ending
capital account balances.
TRUE
30. Blaine contributes property valued at $50,000 (basis of $40,000) in exchange for a 25% interest in the BIKE
Partnership. If the property is later sold for $70,000, gain of $15,000 will be allocated to Blaine.
TRUE
31. Emma’s basis in her BBDE LLC interest is $60,000 at the beginning of the tax year. Her allocable share of
LLC items are as follows: $20,000 of ordinary income, $2,000 tax-exempt interest income, and a $6,000
long-term capital gain. In addition, the LLC distributed $12,000 of cash to Emma during the year. Assuming the
LLC had no liabilities at the beginning or the end of the year, Emma’s ending basis in her LLC interest is
$76,000.
TRUE
32. Ashley purchased her partnership interest from Lindsey on the first day of the current year for $40,000 cash.
She received a $10,000 cash distribution from the partnership during the year, and her share of partnership
income is $15,000. Her share of partnership liabilities on the last day of the partnership year is $20,000.
Ashley’s outside basis for her partnership interest at the end of the year is $45,000.
FALSE
33. Julie and Kate form an equal partnership during the current year. Julie contributes cash of $160,000, and
Kate contributes property (adjusted basis of $90,000, fair market value of $260,000) subject to a nonrecourse
liability of $100,000. As a result of these transactions, Kate has a basis in her partnership interest of $40,000.
FALSE
34. Debt of a limited liability company is allocated among LLC members using the nonrecourse debt allocation
rules unless an LLC member has personally guaranteed the debt.
TRUE
35. The sum of the partners’ ending basis amounts on all Schedules K-1 equals the partners’ ending capital
account balance shown on the partnership’s Schedule L.
FALSE
36. If a partnership allocates losses to the partners, the partners must first apply the passive loss limitations, then
the basis limitation, and finally the at-risk limitations. If all three hurdles are met, the partner may deduct the
loss.
FALSE
37. Harry’s basis in his partnership interest was $10,000 at the beginning of the tax year. For the year, his share
of the partnership’s loss was $8,000, and he also received a distribution of $4,000. Harry can deduct an $8,000
loss, and he recognizes a gain of $2,000 on the distribution of cash in excess of his remaining basis.
FALSE
38. Nicholas, a 1/3 partner with a basis in the interest of $80,000 at the beginning of the year, received a
guaranteed payment in the current year of $50,000. Partnership income before consideration of the guaranteed
payment was $20,000. Nicholas reports a $10,000 ordinary loss from partnership operations, and the $50,000
guaranteed payment as ordinary income.
TRUE
39. William is a general partner in the WST partnership. During the current year, he receives a guaranteed
payment of $10,000 for services he provides to the partnership, and his distributive share of partnership income
is $30,000. William is required to pay self-employment tax on the $10,000 guaranteed payment, but not on his
distributive share of partnership income.
FALSE
40. Maria owns a 60% interest in the KLM Partnership. Four years ago her father gave her a parcel of land. The
gift basis of the land to Maria is $60,000. In the current year, Maria had still not figured out how to use the land
for her own personal or business use; consequently, she sold the land to the partnership for $50,000. The
partnership immediately started using the land as a parking lot for its employees. Maria may recognize her
$10,000 loss on the sale.
FALSE
41. One of the disadvantages of the partnership form is that the partner’s share of the partnership’s taxable
income is taxed to the partner, regardless of whether or not distributed.
TRUE
42. Which of the following entity owners cannot participate in management of the entity?
A. A general partner in a general partnership.
B. A member of a limited liability company.
C. A partner in a limited liability partnership.
D. A limited partner in a limited liability limited partnership.
E. None of the above.
43. Which one of the following statements regarding partnership taxation is incorrect?
A. A partnership is a taxable entity for Federal income tax purposes.
B. Partnership income is comprised of ordinary partnership income or loss and separately stated items.
C. A partnership is required to file a return with the IRS.
D. A partner’s profit-sharing percent may differ from the partner’s loss-sharing percent.
E. All of these statements are correct.
44. Which of the following is a correct definition of a concept related to partnership taxation?
A. The aggregate concept treats partners and partnerships as separate units and gives the partnership its own tax
“personality.”
B. A partner’s capital sharing ratio is defined as the percent of partnership assets (capital) that would be
allocated to the partner upon liquidation of the partnership.
C. The partnership’s outside basis is defined as the sum of each partner’s capital account balance.
D. A special allocation is defined as an amount that could differently affect the tax liabilities of two or more
partners.
E. None of these statements is correct.
45. A partnership will take a carryover basis in an asset it acquires when:
A. The partnership acquires the asset through a § 1031 like-kind exchange.
B. A partner owning 25% of partnership capital and profits sells the asset to the partnership.
C. The partnership leases the asset from a partner on a one-year lease.
D. The partnership acquires the asset from a partner as a contribution to partnership capital under § 721(a).
E. None of the above.
46. On January 1 of the current year, Anna and Jason form an equal partnership. Anna contributes $50,000 cash
and a parcel of land (adjusted basis of $100,000; fair market value of $150,000) in exchange for her interest in
the partnership. Jason contributes property (adjusted basis of $180,000; fair market value of $200,000) in
exchange for his partnership interest. Which of the following statements is true concerning the income tax
results of this partnership formation?
A. Jason recognizes a $20,000 gain on his property transfer.
B. Jason has a $200,000 tax basis for his partnership interest.
C. Anna has a $150,000 tax basis for her partnership interest.
D. The partnership has a $150,000 adjusted basis in the land contributed by Anna.
E. None of the statements is true.
47. Tim, Al, and Pat contributed assets to form the equal TAP Partnership. Tim contributed cash of $40,000 and
land with a basis of $80,000 (fair market value of $60,000). Al contributed cash of $60,000 and land with a
basis of $50,000 (fair market value of $40,000). Pat contributed cash of $60,000 and a fully depreciated
property ($0 basis) valued at $40,000. Which of the following tax treatments is not correct?
A. Tim’s basis in his partnership interest is $120,000.
B. Al realizes and recognizes a loss of $10,000.
C. Pat realizes a gain of $40,000 but recognizes $0 gain.
D. TAP has a basis of $80,000, $50,000, and $0 in the land and property (excluding cash) contributed by Tim,
Al, and Pat, respectively.
E. All of these statement are correct.
48. When property is contributed to a partnership in exchange for a capital and profits interest, when does the
partner’s holding period begin for the partnership interest?
A. The day after the contribution date.
B. The day the property was contributed.
C. The day the contributed property was purchased.
D. The day the partnership interest was acquired.
E. Either (or both) c. and d. may be true, depending upon the types of property contributed.
49. In which of the following independent situations would the transaction most likely be characterized as a
disguised sale?
A. Partner George contributes appreciated property to the GM Partnership, and three years later GM distributes
$100,000 proportionately to the partners.
B. Brianna contributes property with a basis of $20,000 and a fair market value of $50,000 to the BGB
Partnership in exchange for a 20% interest therein. The partnership agrees to distribute $20,000 to Brianna in
fifteen months, if partnership cash flows from operations exceed $100,000 at that time. The partnership does not
expect to produce operating cash flows of over $100,000 for at least five years.
C. Luis contributes appreciated property to the BLP Partnership. Thirty months later, he receives a distribution
from the partnership of $15,000 cash. None of the other partners received a distribution. There was no
agreement that BLP would make the distribution, and Luis would have made the contribution whether or not the
partnership made the distribution.
D. None of the above transactions will be treated as a disguised sale.
E. a., b., and c. are all treated as disguised sales.
50. Tara and Robert formed the TR Partnership four years ago. Because they decided the company needed some
expertise in multimedia presentations, they offered Katie a 1/3 interest in partnership capital if she would come
to work for the partnership. She will also receive a 25% interest in future partnership profits. On July 1 of the
current year, the unrestricted partnership capital interest (fair market value of $25,000) was transferred to Katie.
How should Katie treat the receipt of the partnership interest in the current year?
A. Nontaxable.
B. $25,000 ordinary income.
C. $25,000 short-term capital gain.
D. $25,000 long-term capital gain.
E. None of the above.
51. Which of the following would be currently taxable as ordinary income to the service partner if received in
exchange for services performed for the partnership? (In all cases, assume the interest is not sold within two
years after the time it is granted to the service partner.)
A. A 10% interest in the capital of the partnership that will vest in 3 years.
B. A 20% interest in the future profits of the partnership received in exchange for future services to be
performed for the partnership.
C. A 25% interest in the capital of the partnership where there are no restrictions on transferability of the
interest.
D. A 30% interest in ongoing profits of the partnership where the partnership is not a publicly-traded
partnership and the income stream is not assured.
E. All of the above.
52. Which of the following is an election or calculation made by the partner rather than the partnership?
A. Calculation of a § 199 deduction amount.
B. Whether to capitalize, amortize, or expense research and experimental costs.
C. The partnership’s overall accounting method.
D. Whether to claim a § 179 deduction related to property acquired by the partnership.
E. All of the above elections are made by the partnership.
53. TEC Partners was formed during the current tax year. It incurred $10,000 of organizational expenses,
$80,000 of startup expenses, and $5,000 of transfer taxes to retitle property contributed by a partner. The
property had been held as MACRS property for ten years by the contributing partner, and had an adjusted basis
to the partner of $300,000 and fair market value of $400,000. Which of the following statements is correct
regarding these items?
A. TEC treats the contributed property as a new MACRS asset placed in service on the date the property title is
transferred.
B. TEC must amortize the $10,000 of organizational expenses over 180 months.
C. TEC’s startup expenses are amortized over 60 months.
D. TEC must capitalize the transfer tax and treat if as a new asset placed in service on the date the property is
contributed.
E. None of the above statements are true.
54. Which of the following statements is always correct regarding assets acquired by a newly formed
partnership? If a partner contributes:
A. Depreciable property: the partnership treats the property as newly acquired depreciable property, and may
claim a § 179 deduction.
B. Unrealized (cash-basis) receivables: the partnership will report a capital gain when the receivable is
collected.
C. Inventory (in the partner’s hands): the partnership reports ordinary income if the property is held as a capital
asset and sold within five years of the contribution date.
D. Land valued at less than its basis: the partnership reports a § 1231 loss if the property is sold at a loss.
E. None of these statements is correct.
55. Which of the following statements is always true regarding accounting methods available to a partnership?
A. If a partnership is a tax shelter, it can use the cash method of accounting.
B. If a non-tax-shelter partnership had “average annual gross receipts” of less than $5 million in all prior years,
it can use the cash method.
C. If a partnership has a partner that is a personal service corporation, it cannot use the cash method.
D. If a partnership has a partner that is a C corporation, it cannot use the cash method.
E. All of the above statements are false.
56. Fern, Inc., Ivy, Inc., and Jeremy formed a general partnership. Fern owns a 50% interest and Ivy and Jeremy
each own 25% interests. Fern, Inc. files its tax return on an October 31 year-end; Ivy, Inc., files with a July 31
year-end, and Jeremy is a calendar year taxpayer. Which of the following statements is true regarding the
taxable year the partnership can choose?
A. The partnership must choose the calendar year because it has no principal partners.
B. The partnership must choose an October year-end because Fern, Inc., is a principal partner.
C. The partnership can request permission from the IRS to use a March 31 fiscal year under § 444.
D. The partnership must use the “least aggregate deferral” method to determine its taxable year.
E. None of the above.
57. In the current year, the POD Partnership received revenues of $200,000 and paid the following amounts:
$50,000 in rent and utilities, and $20,000 as a distribution to partner Olivia. In addition, the partnership earned
$6,000 of long-term capital gains during the year. Partner Donald owns a 50% interest in the partnership. How
much income must Donald report for the tax year?
A. $68,000 ordinary income.
B. $78,000 ordinary income.
C. $65,000 ordinary income; $3,000 of long-term capital gains.
D. $75,000 ordinary income; $3,000 of long-term capital gains.
E. None of the above.
58. Kristie is a 30% partner in the KKM Partnership. During the current year, KKM reported gross receipts of
$280,000 and a charitable contribution of $30,000. The partnership paid office expenses of $80,000. In addition,
KKM distributed $20,000 each to partners Kaylyn and Megan, and the partnership paid partner Kaylyn $20,000
for administrative services. Kristie reports the following income from KKM during the current tax year:
A. $54,000 ordinary income; $9,000 charitable contribution.
B. $60,000 ordinary income; $9,000 charitable contribution.
C. $36,000 ordinary income.
D. $54,000 ordinary income.
E. None of the above.
59. Which one of the following is not shown on the partnership’s Schedule K on Page 4 of Form 1065?
A. The partnership’s self-employment income.
B. The partnership’s separately stated income and deductions.
C. The partnership’s tax preference and adjustment items.
D. The partnership’s net operating loss carryforward.
E. All of the above.
60. On a partnership’s Form 1065, which of the following statements is not true?
A. The partnership reconciles its net income (including separately stated items) to book income on Schedule
M-1 or M-3.
B. The partnership balance sheet on Schedule L is generally presented on a financial (book) basis.
C. All partnership income and expense items are reported on Form 1065, page 1.
D. The partnership’s equivalent of taxable income is reported in the “Analysis of Income (Loss).”
E. None of the above statements are true.
61. ABC LLC reported the following items on the LLC’s Schedule K: ordinary income, $100,000; interest
income, $3,000; long-term capital loss, ($4,000); charitable contributions, $1,000; post-1986 depreciation
adjustment, $10,000; and cash distributions to partners, $50,000. How much will ABC show as net income
(loss) on its Analysis of Income (Loss)?
A. $68,000.
B. $78,000.
C. $95,000.
D. $98,000.
E. $102,000.
62. Which of the following statements is not a requirement of the substantial economic effect test?
A. Income, gains, losses, and deductions must be allocated to the partners in accordance with their capital
contributions.
B. An allocation of income must increase the partner’s capital account balance, and an allocation of deduction
must decrease the partner’s capital account balance.
C. A partner with a negative capital account balance must “restore” that capital account, generally by
contributing cash to the partnership.
D. On liquidation of the partner’s interest in the partnership, the partner must receive assets that have a fair
market value equal to that partner’s (positive) capital account balance.
E. All of the above statements are requirements of the substantial economic effect test.
63. Brooke and John formed a partnership. Brooke received a 40% interest in partnership capital and profits in
exchange for contributing land (basis of $30,000 and fair market value of $120,000). John received a 60%
interest in partnership capital and profits in exchange for contributing $180,000 of cash. Three years after the
contribution date, the land contributed by Brooke is sold by the partnership to a third party for $150,000. How
much taxable gain will Brooke recognize from the sale?
A. $102,000.
B. $90,000.
C. $48,000.
D. $36,000.
E. $0.
64. Mark and Addison formed a partnership. Mark received a 25% interest in partnership capital and profits in
exchange for land with a basis of $40,000 and a fair market value of $60,000. Addison received a 75% interest
in partnership capital and profits in exchange for $180,000 of cash. Three years after the contribution date, the
land contributed by Mark is sold by the partnership to a third party for $76,000. How much taxable gain will
Mark recognize from the sale?
A. $0.
B. $9,000.
C. $24,000.
D. $36,000.
E. None of the above.
65. Ryan is a 25% partner in the ROCC Partnership. At the beginning of the tax year, Ryan’s basis in the
partnership interest was $90,000, including his share of partnership liabilities. During the current year, ROCC
reported net ordinary income of $100,000. In addition, ROCC distributed $10,000 to each of the partners
($40,000 total). At the end of the year, Ryan’s share of partnership liabilities increased by $10,000. Ryan’s basis
in the partnership interest at the end of the year is:
A. $90,000.
B. $100,000.
C. $115,000.
D. $125,000.
E. None of the above.
66. Allison is a 40% partner in the BAM Partnership. At the beginning of the tax year, Allison’s basis in the
partnership interest was $100,000, including her share of partnership liabilities. During the current year, BAM
reported an ordinary loss of $60,000. In addition, BAM distributed $8,000 to Allison and paid partner Brian a
$20,000 consulting fee (neither of these amounts was deducted in determining the $60,000 loss from
operations). At the end of the year, Allison’s share of partnership liabilities decreased by $10,000. Assuming
loss limitation rules do not apply, Allison’s basis in the partnership interest at the end of the year is:
A. $2,000.
B. $50,000.
C. $70,000.
D. $100,000.
E. None of the above.
67. Binita contributed property with a basis of $40,000 and a value of $50,000 to the BE Partnership in
exchange for a 20% interest in partnership capital and profits. During the first year of partnership operations,
BE had net taxable income of $30,000 and tax-exempt interest income of $10,000. The partnership distributed
$10,000 cash to Binita. Binita’s adjusted basis (outside basis) for her partnership interest at year-end is:
A. $36,000.
B. $38,000.
C. $60,000.
D. $70,000.
E. None of the above.
68. At the beginning of the year, Heather’s “tax basis” capital account balance in the HEP Partnership was
$85,000. During the tax year, Heather contributed property with a basis of $6,000 and a fair market value of
$10,000. Her share of the partnership’s ordinary income and separately stated income and deduction items was
$40,000. At the end of the year, the partnership distributed $15,000 of cash to Heather. Also, the partnership
allocated $12,000 of recourse debt and $10,000 of nonrecourse debt to Heather. What is Heather’s ending
capital account balance determined using the “tax basis” method?
A. $116,000.
B. $120,000.
C. $126,000.
D. $128,000.
E. $138,000.
69. Misty and John formed the MJ Partnership. Misty contributed $50,000 of cash in exchange for her 50%
interest in the partnership capital and profits. During the first year of partnership operations, the following
events occurred: the partnership had a net taxable income of $20,000; Misty received a distribution of $12,000
cash from the partnership; and Misty had a 50% share in the partnership’s $60,000 of recourse liabilities on the
last day of the partnership year. Misty’s adjusted basis for her partnership interest at year end is:
A. $48,000.
B. $60,000.
C. $78,000.
D. $88,000.
E. $90,000.
70. Which of the following statements is correct regarding the manner in which partnership liabilities are
reflected in the partners’ bases in their partnership interests?
A. Nonrecourse debt is allocated to the partners according to their loss-sharing ratios.
B. Recourse debt is allocated to the partners to the extent of the partnership’s minimum gain in the property.
C. An increase in partnership debts results in a decrease in the partners’ bases in the partnership interest.
D. A decrease in partnership debt is treated as a distribution from the partnership to the partner and reduces the
partner’s basis in the partnership interest.
E. Partnership debt is not reflected in the partners’ bases in their partnership interests.
71. Alicia and Barry form the AB Partnership at the start of the current year with a land contribution by Barry
and a cash contribution by Alicia. Barry’s contributed property is subject to a recourse mortgage assumed by the
partnership. Barry has an 80% interest in AB’s profits and losses. The land has been held by Barry for the past 6
years as an investment. It will be used by AB as an operating asset in its parking lot business. Which of the
following statements is correct?
A. Immediately after formation, Alicia’s basis in the partnership equals the cash contributed by Alicia.
B. Immediately after formation, Alicia’s basis in the partnership equals the cash she contributed plus her share
of the recourse debt contributed by Barry.
C. Because the debt is recourse, the constructive liquidation scenario is not applicable for determining the
allocation of debt to the partners.
D. AB’s basis in the land contributed by Barry equals Barry’s basis in the land immediately before the
contribution date, less the amount of the recourse debt assumed by the partnership.
E. None of the above.
72. Sharon contributed property to the newly formed QRST Partnership. The property had a $100,000 adjusted
basis to Sharon and a $160,000 fair market value on the contribution date. The property was also encumbered
by a $120,000 nonrecourse debt, which was transferred to the partnership on that date. Another partner,
Rochelle, shares 30% of the partnership income, gain, loss, deduction, and credit. Under IRS regulations,
Rochelle’s share of the nonrecourse debt for basis purposes is:
A. $20,000.
B. $30,000.
C. $36,000.
D. $100,000.
E. $120,000.
73. During the current tax year, Jordan and Whitney each contributed $50,000 to form the J&W LLC. Each
member has a 50% interest in LLC capital, profits, and losses, except that depreciation expense is allocated 40%
to Jordan and 60% to Whitney. During the first year, the LLC reported income (before depreciation expense) of
$20,000 and had depreciation expense of $10,000. The LLC incurred recourse debt (that was personally
guaranteed by both of the LLC members) of $60,000. Partnership assets are $170,000 at the end of the year.
Under the constructive liquidation scenario, how is the recourse debt allocated to Jordan and Whitney?
A. The recourse debt is shared equally ($30,000 each) by Jordan and Whitney.
B. The recourse debt is allocated $36,000 to Whitney and $24,000 to Jordan.
C. The recourse debt is allocated $31,000 to Whitney and $29,000 to Jordan.
D. The recourse debt is allocated $29,000 to Whitney and $31,000 to Jordan.
E. The recourse debt is allocated $24,000 to Whitney and $36,000 to Jordan.
74. Which of the following is not a specific adjustment to the partners’ basis in the partnership interest?
A. Increased by contributions the partner made to the partnership.
B. Decreased by the amount of guaranteed payments shown on the partner’s Schedule K-1.
C. Increased by the partner’s share of tax-exempt income.
D. Decreased by any decrease in the partner’s share of partnership liabilities.
E. Increased by the partner’s share of separately stated income items.
75. Rebecca is a limited partner in the RST Partnership, which is not publicly traded. Her allocable share of
RST’s passive ordinary losses from a nonrealty activity for the current year is ($60,000). Rebecca has a $40,000
adjusted basis (outside basis) for her interest in RST (before deduction of any of the passive losses). Her amount
“at risk” under § 465 is $30,000 (before deduction of any of the passive losses). She also has $25,000 of passive
income from other sources. How much of her ($60,000) allocable loss can Rebecca deduct on her current year’s
tax return?
A. $25,000.
B. $30,000.
C. $40,000.
D. $60,000.
E. None of the above.
76. At the beginning of the tax year, Zach’s basis for his partnership interest and his amount at risk in the
partnership was $30,000. His share of partnership items for the year consisted of tax-exempt interest income of
$2,000 and an ordinary loss of $44,000. He also received a distribution from the partnership of $20,000 cash
during the year. For the tax year, Zach will report:
A. A nontaxable distribution of $20,000, an ordinary loss of $10,000, and a suspended loss carryforward of
$34,000.
B. An ordinary loss of $32,000, a suspended loss carryforward of $12,000, and a taxable distribution of
$20,000.
C. A nontaxable distribution of $20,000, an ordinary loss of $12,000, and a suspended loss carryforward of
$32,000.
D. An ordinary loss of $44,000 and a nontaxable distribution of $20,000.
77. Paul sells one parcel of land (basis of $100,000) for its fair market value of $160,000 to a partnership in
which he owns a 60% capital interest. Paul held the land for investment purposes. The partnership is in the real
estate development business, and will build residential housing (for sale to customers) on the land. Paul will
recognize:
A. $0 gain or loss.
B. $36,000 ordinary income.
C. $36,000 capital gain.
D. $60,000 ordinary income.
E. $60,000 capital gain.
78. Molly is a 30% partner in the MAP Partnership. During the current tax year, the partnership reported
ordinary income of $200,000 before payment of guaranteed payments and distributions to partners. The
partnership made an ordinary cash distribution of $20,000 to Molly, and paid guaranteed payments to partners
Molly, Amber, and Pat of $20,000 each ($60,000 total). How much will Molly’s adjusted gross income increase
as a result of the above items?
A. $42,000.
B. $60,000.
C. $62,000.
D. $80,000.
E. None of the above.
79. Stephanie is a calendar year cash basis taxpayer. She owns a 50% profit and loss interest in a cash basis
partnership with a September 30 year-end. The partnership’s operating income (after deducting guaranteed
payments) was $120,000 ($10,000 per month) and $144,000 ($12,000 per month), respectively, for the
partnership tax years ended September 30, 2013 and 2014. The partnership paid guaranteed payments to
Stephanie of $2,000 and $3,000 per month during the fiscal years ended September 30, 2013 and 2014. How
much will Stephanie’s adjusted gross income be increased by these partnership items for her tax year ended
December 31, 2013?
A. $60,000.
B. $72,000.
C. $84,000.
D. $90,000.
E. $108,000.
80. Samuel is the managing general partner of STU, in which he owns a 25% interest. For the year, STU
reported ordinary income of $400,000 (after deducting all guaranteed payments). In addition, the LLC reported
interest income of $10,000. Samuel received a guaranteed payment of $120,000 for services he performed for
STU. How much income from self-employment did Samuel earn from STU?
A. $100,000.
B. $120,000.
C. $220,000.
D. $222,000.
E. None of the above.
81. Which of the following is not a correct statement regarding the advantage of the partnership entity form
over the subchapter C corporate form?
A. A partnership typically has easier administrative and filing requirements than does a C corporation.
B. Partnership income is subject to a single level of taxation; corporate income is double taxed.
C. Partnerships may specially allocate income and expenses among the partners, provided the substantial
economic effect requirements are met; corporate dividends must be proportionate to shareholdings.
D. Partners in a general partnership have less personal liability for entity claims than shareholders of a C
corporation.
E. All of the above are advantages of partnership taxation.
82. Match each of the following statements with the terms below that provide the best definition.
1. Check the box
regulations
2. Syndication costs
3. Limited partnership
4. Disguised sale
5. Aggregate concept
6. Substituted
7. General partnership
8. Qualified
nonrecourse debt
9. Limited liability
company
10. Carryover
11. Separately stated
item
12. Profits interest
13. Entity concept
14. Limited liability
partnership
Must have at least one general and one limited
partner.
Allows many unincorporated entities to select their
Federal tax status.
Partner’s percentage allocation of current operating
income.
Organizational choice of many large accounting
firms.
Theory treating the partnership as a collection of
taxpayers joined in an agency relationship.
Partner’s basis in partnership interest after tax-free
contribution of asset to partnership.
Owners are “members.”
No correct match provided.
Brokerage and registration fees incurred for
promoting and marketing partnership interests.
Transfer of asset to partnership followed by
immediate distribution of cash to partner.
Might affect any two partners’ tax liabilities in
different ways.
Partnership’s basis in asset after tax-free
contribution of asset to partnership.
Theory treating the partner and partnership as
separate economic units.
All partners are jointly and severally liable for
entity debts.
3
1
12
14
5
6
9
8
2
4
11
10
13
7
83. George and James are forming the GJ Partnership. George contributes $600,000 cash and James contributes
nondepreciable property with an adjusted basis of $400,000 and a fair market value of $750,000. The property
is subject to a $150,000 liability, which is also transferred into the partnership and is shared equally by the
partners for basis purposes. George and James share in all partnership profits equally except for any
precontribution gain, which must be allocated according to the statutory rules for built-in gain allocations.
a.
What is James’s adjusted tax basis for his partnership interest immediately after the partnership is formed?
b.
What is the partnership’s adjusted basis for the property contributed by James?
c.
If the partnership sells the property contributed by James for $800,000, how is the tax gain allocated between the partners?
a.
James’s adjusted basis in the partnership interest is $325,000.
Computation:
Basis of property contributed
Plus: James’s share of partnership liability
Less: James’s liability transferred to partnership
b.
Partnership’s basis (carryover basis) is $400,000.
c.
James is allocated $375,000 of the gain and George is allocated gain of $25,000.
$400,000
75,000
(150,000)
$325,000
Computation:
Sales price
Less: Adjusted basis
Total gain on sale
Built-in (precontribution) gain
Remaining gain
Gain allocated to partner
$800,000
(400,000)
$400,000
James
$350,000
25,000
$375,000
George
$ –0–
25,000
$25,000
84. Palmer contributes property with a fair market value of $4,000,000 and an adjusted basis of $3,000,000 to
AP Partnership. Palmer shares in $1,000,000 of partnership debt under the liability sharing rules, giving him an
initial adjusted basis for his partnership interest of $4,000,000. One month after the contribution, Palmer
receives a cash distribution from the partnership of $2,000,000. Palmer would not have contributed the property
if the partnership had not contractually obligated itself to make the distribution. Assume Palmer’s share of
partnership liabilities will not change as a result of this distribution.
a.
Under the IRS’s likely treatment of this transaction, what is the amount of gain or loss that Palmer will recognize because of the
$2,000,000 cash distribution?
b.
What is the partnership’s basis for the property after the distribution?
c.
If Palmer is unhappy with this result, can you suggest a possible alternative that may provide him with a better answer?
a.
Palmer will likely recognize a $500,000 [($4,000,000 – $3,000,000) ´ 50% ] gain on the transaction. Palmer received a cash payment equal
to one-half the value of the property he contributed. The IRS would likely treat this as a disguised sale of the property. A disguised sale is
presumed to occur when a contractual agreement requires a contribution by a partner to be followed within two years by a specified
distribution by the partnership, and the distribution is made without regard to partnership profits. Both these issues occur in this scenario.
While Palmer could argue that the intent of this transaction is not to create a disguised sale, it is doubtful that he would be successful.
b.
The partnership’s total basis for the property is $3,500,000. Its basis for the purchased property is the $2,000,000 cost of the property (the
partnership is deemed to have paid for the property). In addition, the partnership has a $1,500,000 carryover basis for the portion of the
property that was not “purchased.”
c.
If Palmer can wait for more than two years to receive the distribution and if the distribution is not contractually guaranteed, the
contribution and distribution transactions will be presumed not to be a disguised sale. The distribution will be treated as a normal
distribution that will not create capital gain for Palmer unless the distribution amount exceeds the adjusted basis for his partnership interest
when the distribution is made.
85. During the current year, MAC Partnership reported the following items of receipts and expenditures:
$600,000 sales, $80,000 utilities and rent, $200,000 salaries to employees, $20,000 guaranteed payment to
partner Antonio, investment interest income of $4,000, a charitable contribution of $8,000, and a distribution of
$30,000 to partner Carl. Antonio is a 25% general partner. Based on this information, what items will be
reflected on Antonio’s Schedule K-1?
The partnership’s ordinary taxable income is:
Sales
Utilities and rent
Salaries
Guaranteed payment to Antonio
Partnership ordinary income
$600,000
(80,000)
(200,000)
(20,000)
$300,000
The partnership also reports the following information:
Separately stated interest income
$
4,000
Guaranteed payment to partner
$ 20,000
Separately stated charitable contribution
$
8,000
The distribution to Carl is not deductible by the partnership. Antonio’s share of the partnership’s ordinary income is $75,000 ($300,000 ´
25%). Antonio also reports his separately stated share of interest income ($1,000, or $4,000 ´ 25%) and charitable contributions ($2,000, or $8,000 ´
25%). Antonio’s K-1 will also show his guaranteed payment of $20,000, his net earnings from self-employment ($95,000 = $75,000 ordinary
income + $20,000 guaranteed payment), and other information he might need in order to prepare his return (e.g., AMT or investment income
information).
86. The LN partnership reported the following items of income and deduction during the current tax year:
revenues, $300,000; cost of goods sold, $180,000; tax-exempt interest income, $2,000; salaries to employees,
$80,000; and long-term capital gain, $10,000. In addition, the partnership distributed $20,000 of cash to 50%
partner Nina and $10,000 of cash to 50% partner Len. What is Nina’s share of ordinary partnership income and
separately stated items?
The partnership’s ordinary taxable income is:
Revenues
$300,000
Cost of goods sold
(180,000)
Salaries
(80,000)
Partnership ordinary income
$ 40,000
Nina’s share ($40,000 ´ 50%)
$ 20,000
Separately stated tax-exempt income (not reported)
Separately stated long-term capital gain (reported)
$
$
1,000
5,000
The distributions to the partners are not deductible.
87. Carli contributes land to the newly formed CD Partnership in exchange for a 30% interest. The land has an
adjusted basis and fair market value of $300,000 and is subject to a liability of $100,000, which the partnership
assumes. None of this liability is repaid at year-end. At the end of the year, the partnership has trade accounts
payable of $20,000. Assume all liabilities are allocated proportionately to the partners. Total partnership income
for the year is $400,000. What is Carli’s basis in her partnership interest at the end of the year?
Carli’s basis in the partnership interest at the end of the year is determined as follows:
Basis in land contributed to CD
Less: relief of liability assumed by partnership
Plus: share of liability related to land ($100,000 ´ 30%)
Plus: share of trade accounts payable ($20,000 ´ 30%)
Plus: share of partnership income
Ending basis in partnership interest
$300,000
(100,000)
30,000
6,000
120,000
$356,000
88. An examination of the RB Partnership’s tax books provides the following information for the current year:
Operating (ordinary) income before guaranteed payments
Long-term capital gain
Guaranteed payment to Rachel for services
Cash distributions to each partner
Interest on Colorado state bonds (exempt interest income)
Charitable contributions made by partnership
Decrease in partnership liabilities from 1/1-12/31
$300,000
6,000
30,000
20,000
2,000
10,000
(20,000)
Rachel is a 30% general partner in partnership capital, profits, and losses. Assume the adjusted basis of her partnership interest is $60,000 at the
beginning of the year, and she shares in 30% of the partnership’s liabilities for basis purposes.
a.
What is Rachel’s adjusted basis for the partnership interest at the end of the year?
b.
How much income must Rachel report on her tax return for the current year? What is the character of income?
a.
Rachel’s adjusted basis for her partnership interest is $114,400.
Adjusted basis, beginning of year
Plus: Share of income after guaranteed payment ($270,000 ´ 30%)
Long-term capital gain
Share of interest on Colorado state bonds
Less: Decrease in share of partnership liabilities
Cash distributions
Share of partnership charitable deductions
Adjusted basis, 12/31
b.
$60,000
$81,000
1,800
600
$ 6,000
20,000
3,000
83,400
(29,000)
$114,400
Rachel will report $81,000 of income from the partnership plus a long-term capital gain of $1,800. She may be able to deduct $3,000 of
charitable contributions as an itemized deduction. In addition, Rachel must report the $30,000 guaranteed payment as income. The bond
interest income is nontaxable and the related interest expense is nondeductible. Her guaranteed payment ($30,000) and her distributive
share ($81,000) will both be subject to SE tax because she is a general partner.
89. Katherine invested $80,000 this year to purchase a 30% interest in the KLM Partnership. The partnership
reported $200,000 of net income from operations, a $2,000 short-term capital loss, and a $10,000 charitable
contribution. In addition, the partnership distributed $20,000 to Katherine and $10,000 each to partners Lauren
and Missy. Assuming the partnership has no beginning or ending liabilities, what is Katherine’s basis in her
partnership interest at the end of the year?
$116,400. Katherine’s initial basis of $80,000 is increased by her 30% share of partnership income from
operations ($60,000). Her basis is decreased by her 30% share of the partnership’s charitable contribution
($3,000) and the short-term capital loss ($600). It is also decreased by the $20,000 distribution she received.
The distributions to Lauren and Missy do not affect Katherine’s basis. Katherine’s ending basis, then, is
$116,400 ($80,000 + $60,000 – $600 – $3,000 – $20,000).
90. Sarah contributed fully depreciated ($0 basis) property valued at $50,000 to the RSTU Partnership in
exchange for a 25% interest in partnership capital and profits. During the first year of partnership operations,
RSTU had net taxable income of $200,000 and tax-exempt income of $4,000. The partnership distributed
$10,000 cash to Sarah. Her share of partnership recourse liabilities on the last day of the partnership year was
$20,000. What is Sarah’s adjusted basis (outside basis) for her partnership interest at the end of the tax year?
$61,000. Sarah is a 25% partner and will share in 25% of the partnership’s taxable income and tax-exempt
income. In addition, her basis will include her allocable share of the partnership’s recourse liabilities. Her
basis will be reduced by the cash distribution during the year. Sarah’s ending basis is calculated as follows:
Beginning basis
Plus: Share of partnership ordinary income (25% ´ $200,000)
Plus: Share of tax-exempt income (25% ´ $4,000)
Plus: Share of partnership liabilities
Basis before losses and distributions
Less: Distribution
Ending basis
$ –0–
50,000
1,000
20,000
$71,000
(10,000)
$61,000
91. In the current year, the DOE LLC received revenues of $200,000 and paid the following amounts: $50,000
in rent and utilities, a $40,000 guaranteed payment to 50% member Dave, $10,000 to member Ethan for
consulting services, and $10,000 as a distribution to member Olivia. In addition, the LLC earned $2,000 of
tax-exempt interest income during the year. Dave is the managing member of the LLC. Dave’s basis in his LLC
interest was $50,000 at the beginning of the year, and includes a $12,000 share of LLC liabilities. At the end of
the year, his share of the LLC’s liabilities was $20,000.
a.
How much income must Dave report for the tax year and what is the character of the income?
b.
What is Dave’s basis in his LLC interest at the end of the tax year?
c.
On what income will Dave’s self-employment tax be calculated?
a.
The LLC’s ordinary income is calculated as follows:
Revenues
Less: rent and utilities
Less: guaranteed payment to Dave
Less: consulting expenses to Ethan
Ordinary income
$200,000
(50,000)
(40,000)
(10,000)
$100,000
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92. Sharon and Sue are equal partners in the S&S Partnership. On January 1 of the current year, each partner’s
adjusted basis in S&S was $80,000 (including each partner’s $20,000 share of the partnership’s $40,000 of
liabilities). During the current year, S&S repaid $30,000 of the debt and borrowed $20,000 for which Sharon
and Sue are equally liable. In the current year ended December 31, S&S also sustained a net operating loss of
$40,000 and earned $10,000 of interest income from investments. If liabilities are shared equally by the
partners, on January 1 of the next year how much is each partner’s basis in her interest in S&S?
$60,000. Each partner’s initial basis in the partnership is $80,000. The basis is reduced by the $15,000 of
repaid debt and increased by each partner’s $10,000 share of new liabilities. Each partner’s basis is then
reduced by the $20,000 share of the net operating loss and increased by the $5,000 share of interest income, as
follows:
Beginning basis
Plus: share of interest income
Less: decrease in share of partnership debt
Less: share of S&S loss
Ending basis
$80,000
5,000
(5,000)
(20,000)
$60,000
93. In the current year, the CAR Partnership received revenues of $400,000 and paid the following amounts:
$160,000 in rent, utilities, and salaries; a $40,000 guaranteed payment to partner Ryan; $20,000 to partner Amy
for consulting services; and a $40,000 distribution to 25% partner Cameron. In addition, the partnership realized
a $12,000 net long-term capital gain. Cameron’s basis in his partnership interest was $60,000 at the beginning
of the year, and included his $25,000 share of partnership liabilities. At the end of the year, his share of
partnership liabilities was $15,000.
a.
How much income must Cameron report for the tax year?
b.
What is Cameron’s basis in the partnership interest at the end of the year?
a.
$45,000 ordinary income and $3,000 LTCG. The partnership’s ordinary income is calculated as follows:
Revenues
Less: rent, utilities, and salaries
Less: guaranteed payment to Ryan
Less: consulting expenses to Amy
Ordinary income
b.
$400,000
(160,000)
(40,000)
(20,000)
$180,000
The distribution to Cameron is not deductible. The payment to Amy is a deductible business expense. Cameron’s
share of CAR’s ordinary income is $45,000. The $12,000 net long-term capital gain is a separately stated item, of
which Cameron’s share is $3,000.
Cameron’s basis in his partnership interest is calculated as follows:
Beginning basis
Plus: share of ordinary income
Plus: share of net long-term capital gain
Less: decrease in share of partnership liabilities
Less: cash distribution to Cameron
Ending basis
$60,000
45,000
3,000
(10,000)
(40,000)
$58,000
94. In the current year, Derek formed an equal partnership with Cody. Derek contributed land with an adjusted
basis of $110,000 and a fair market value of $200,000. Derek also contributed $50,000 cash to the partnership.
Cody contributed land with an adjusted basis of $80,000 and a fair market value of $230,000. The land
contributed by Derek was encumbered by a $60,000 nonrecourse debt. The land contributed by Cody was
encumbered by $40,000 of nonrecourse debt. Assume the partners share debt equally. Immediately after the
formation, what is the basis of Cody’s partnership interest?
$90,000. Cody’s basis is determined as follows:
Basis of land
Deemed cash distribution (relief of Cody’s debt)
Share of Cody’s debt
Share of Derek’s debt
Cody’s basis
$80,000
(40,000)
20,000
30,000
$90,000
95. Morgan is a 50% managing member in the calendar year, cash basis MKK LLC. The LLC received
$150,000 income from services and paid the following other amounts:
Rent expense
Salary expense to employees
Payment to Morgan for services, per the operating agreement
Distributions to partners, Kristin and Katie
Payment to 30% cash basis partner Katie for tax and accounting services
$10,000
40,000
30,000
12,000
10,000
How much will Morgan’s adjusted gross income increase as a result of the above items? What amount will be included in Morgan’s self-employment
tax calculation?
$60,000 income and amount included in SE tax calculation. The $30,000 payment to Morgan is a guaranteed
payment and is deductible by the partnership. The $10,000 payment to Katie is deductible under § 707(a),
because it was paid during the year. The distributions to Kristen and Katie are not deductible by the partnership.
The partnership’s ordinary income, then, is $60,000.
Income from services
Less: Rent expense
Salaries to employees
Guaranteed payment to Morgan
Payment to Katie for services
Partnership income
$150,000
$10,000
40,000
30,000
10,000
(90,000)
$ 60,000
Of this $60,000 partnership income, 50%, or $30,000, is allocated to Morgan. She must also include the $30,000 guaranteed payment in her gross
income this year, as she and the partnership use the same reporting period. This $60,000 is included in Morgan’s SE tax calculation.
96. The MOP Partnership is involved in leasing heavy equipment under long-term leases of five years or more.
Patricia has an adjusted basis for her partnership interest on January 1 of the current year of $600,000,
consisting of the following:
Capital account
Share of partnership recourse debt
Share of partnership nonrecourse debt
$350,000
50,000
200,000
$600,000
During the year, the partnership has an operating loss of $1.2 million and distributes $60,000 of cash to Patricia. Partnership liabilities were the same
at the end of the tax year, and the nonrecourse debt is not “qualified nonrecourse debt.” If she owns a 60% share of partnership profits, capital, and
losses, and is a material participant in the partnership, how much of her share of the operating loss can Patricia deduct? What Code provisions could
cause a suspension of the loss? How would your answer change if MOP were an LLC and Patricia had not personally guaranteed any of the debt?
Patricia can only deduct $340,000 of her $720,000 share of the partnership’s operating loss on her tax return.
Patricia’s adjusted basis for her partnership interest immediately before the deduction of any portion of the loss
is $540,000 ($600,000 – $60,000 distribution). The amount of the loss that can be deducted is first limited by
the $540,000 adjusted basis. Then, the remaining loss is limited by the “at-risk” amount of $340,000 ($600,000
– $60,000 distribution – $200,000 nonrecourse debt). (Patricia is not “at risk” for her $200,000 share of the
nonrecourse debt.) The passive loss rules do not apply, since Patricia is a material participant in the partnership.
Therefore, she can deduct a $340,000 loss on her return.
Deductible
$540,000
340,000
Not applicable
Adjusted basis [§ 704(d)]
At risk amount (§ 465)
Passive loss rules (§ 469)
Suspended
$180,000
200,000
If MOP were an LLC, the nominally recourse debt of $50,000 would not be included in Patricia’s amount at risk because she did not personally
guarantee the debt. Her deductible loss would be limited to $290,000 ($340,000 – $50,000).
97. Cassandra is a 10% limited partner in C&C, Ltd. Her basis in the interest is $60,000 before loss allocations,
including her $30,000 share of the partnership’s nonrecourse debt. (This debt is not qualified nonrecourse
financing.) Cassandra is also a 10% limited partner in MNOP, in which her basis is $30,000. Cassandra is
allocated an $80,000 loss from C&C, and $20,000 of income from MNOP. How much of the loss from C&C
may Cassandra deduct? Under what Code provisions are the remaining losses suspended?
Cassandra’s $80,000 loss from C&C is first limited by the basis rules of § 704(d); $20,000 of the loss ($80,000
loss – $60,000 basis) is limited under this rule. The remaining $60,000 loss is tested under the at-risk rules.
Cassandra’s amount at risk is $30,000 (her basis less the nonrecourse debt); $30,000 of the loss ($60,000 –
$30,000) is suspended under the at-risk rules. As a limited partner, the remaining $30,000 loss is treated as a
passive loss. That loss can be deducted to the extent of Cassandra’s passive income from MNOP, or $20,000.
The remaining $10,000 of loss is suspended under the passive loss rules.
Adjusted basis [§ 704(d)]
At risk amount (§ 465)
Passive loss rules
Deductible
$60,000
30,000
20,000
Suspended
$20,000
30,000
10,000
98. Jeordie and Kendis created the JK Partnership by contributing $100,000 each. The $200,000 cash was used
by the partnership to acquire a depreciable asset. The partnership agreement provides that the partners’ capital
accounts will be maintained in accordance with Reg. § 1.704-1(b) (the “economic effect” Regulations) and that
any partner with a deficit capital account will be required to restore that capital account when the partner’s
interest is liquidated. The partnership agreement provides that MACRS will be allocated 20% to Jeordie and
80% to Kendis. All other items of partnership income, gain, loss, deduction, and credit will be allocated equally
between the partners. In the first year, MACRS is $40,000 and no other operating transactions occur. The
property is sold at the end of the year for $160,000 and the partnership is liquidated immediately thereafter.
To satisfy the economic effect test, how much of the $160,000 cash (from the sale) is allocated each to Jeordie
and Kendis?
Distributions upon liquidation must follow the capital accounts for each partner. After MACRS allocations,
Jeordie will have a capital account balance of $92,000 ($100,000 – $8,000) and Kendis’s capital account
balance will be $68,000 ($100,000 – $32,000). If the asset is sold for its $160,000 carrying value on the
partnership books, no gain or loss will be recognized on the sale and, therefore, no further adjustment needs to
be made to the partner’s capital accounts. Upon liquidation, the partners will receive the balances in their capital
accounts.
99. Allison and Taylor form a partnership by each making contributions of $90,000 cash to partnership capital.
The partnership purchases an asset for $600,000, using the cash and financing the rest with a $420,000 recourse
note. The partners expect the partnership to have losses for the first three years of operations and profits
thereafter. Allison is allocated 75% of partnership losses until the date when the total partnership profits
exceed total partnership losses. After that date, the profits and losses are shared equally between the two
partners. How will the recourse debt be shared between the partners for basis purposes immediately after the
property is acquired?
The recourse debt will be allocated $360,000 to Allison and $60,000 to Taylor. According to the constructive
liquidation scenario, the $600,000 partnership asset is deemed worthless. The asset is deemed to be sold for the
$0 value and the loss is allocated $450,000 to Allison and $150,000 to Taylor. This reduces Allison’s capital
account to a deficit of ($360,000) and Taylor’s to a deficit of ($60,000). Each partner is then deemed to
contribute cash to the partnership to eliminate this capital account deficit (Allison contributes $360,000; Taylor
contributes $60,000). The partnership is deemed to use these cash contributions to pay the $420,000 partnership
liability.
Constructive liquidation scenario computations:
Original capital accounts
Allocation of deemed loss
Balance in capital accounts
Deemed cash contributions (allocation of debt)
Ending capital
Allison
$ 90,000
(450,000)
($360,000)
360,000
$
–0–
Taylor
$ 90,000
(150,000)
($ 60,000)
60,000
$
–0–
100. On the formation of a partnership, when might a “disguised sale” occur? How can this treatment be
avoided?
A disguised sale might occur when a partner contributes appreciated property to a partnership and soon
thereafter receives a cash distribution from the partnership. Under §§ 721 and 731, the contribution and
distribution transactions normally would not be taxable events if the partner has sufficient basis to cover the
distribution.
If the appearance of the transaction is that the contribution and distribution are related, the IRS may take the
position that the partnership form was simply used to accommodate a transaction that was intended to be a sale.
Disguised sale treatment can be avoided if the distribution is not abnormal (e.g., the other partners receive
similar and proportionate distributions); the partnership is not obligated to make the distribution; at the
contribution date, the partner’s rights to future distributions are clearly subject to entrepreneurial risk; or the
distribution is more than two years after the contribution occurred.
101. Your client owns a parcel of land that has depreciated in value. He wants to know if there is a way he can
contribute the property to his partnership, have the partnership sell the property, and convert the existing capital
loss into an ordinary loss. He also wants to know if part of the loss would be allocated to his other partners.
What is your reaction?
In the short run, it would not be possible to convert the capital loss into an ordinary loss. If the client can wait
more than five years for the partnership to sell the property, the character of the loss would be determined by
reference to the partnership’s use of the land. The built-in (precontribution) loss would be allocated to the client
and any loss arising after the contribution date would be allocated according to the provisions in the partnership
agreement.
Section 724 provides that when property is sold by a partnership at a loss within five years of the date the
property is contributed, any built-in capital loss at the contribution date remains a capital loss, regardless of the
partnership’s use of the property. For example, even if the land was considered inventory by the partnership
rather than a capital asset, sale of that land within five years would result in a capital loss to the extent of the
built-in loss at the contribution date.
When a partner contributes property to a partnership, any built-in gain or loss must be tracked and allocated to
the contributing partner under § 704(c). Therefore, the built-in loss would be allocated to the client when the
property is eventually sold.
102. What are “syndication costs” and how are they treated for tax purposes?
Syndication costs are costs incurred in bringing an investment partnership to market. These costs include
brokerage commissions and fees; registration fees; legal and accounting fees for developing the offering
document; and printing and distribution costs for the prospectus, placement memoranda, and related documents.
Under § 709, syndication costs cannot be deducted and no amortization is permitted. Upon termination of the
partnership, the partners’ basis will theoretically still include those costs, so the partner might have a lower gain
or a greater loss at that time. (See Chapter 11 for treatment of liquidating distributions and limitations on when a
loss can be recognized.)
103. Harry and Sally are considering forming a partnership. Both taxpayers use the calendar year and are cash
basis taxpayers. The partnership will not be a tax shelter. The partners are uncertain as to whether the
partnership should use the cash or accrual method of accounting. Also, the idea of a tax deferral in the first year
of operations has led them to consider using a June 30 fiscal year-end for the partnership.
As their tax adviser, identify the issues that must be considered in selecting an accounting method and tax year
for the partnership.
Because neither partner is a Subchapter C corporation and the partnership is not a tax shelter, the partnership
may select any accounting method: cash, accrual, or a hybrid of the two methods.
If the partnership uses the accrual method of accounting in determining its income, the partners will be taxed on
partnership revenues from all “closed” transactions. In this regard, it does not matter whether cash has been
received by the partnership and whether or not the partners use the accrual method on their individual tax
returns. Thus, if the partnership adopts the accrual method for tax purposes, the partners may be faced with
reporting and paying taxes on partnership income long before cash is available for distribution.
Regarding the July 1 to June 30 fiscal year, the desired tax deferral has little chance of success. Under § 706(b),
the partnership must use the calendar year unless Harry and Sally can convince the IRS that a business purposes
exists for a tax year other than the calendar year. Nothing in the fact pattern indicates a valid business purpose
exists for a fiscal year. The partnership may also elect to use a tax year other than the required tax year if the
deferral period is three months or less (e.g., September, October or November year-end), and if the partnership
agrees to deposit tax on the deferred income at a specified tax rate. This election cannot be used in this situation
to obtain a July 1 to June 30 fiscal year.
104. The MOG Partnership reports ordinary income of $60,000, long-term capital gain of $12,000, and
tax-exempt income of $12,000. The partnership agreement provides that Molly will receive all long-term capital
gains and George will receive all tax-exempt interest income. Their allocation of ordinary income will be
reduced accordingly, and Olivia will be allocated a proportionately greater share of ordinary income. (In other
words, each partner will receive allocations totaling 1/3 of the total $84,000 of partnership income.) This
allocation was agreed upon because Molly and George are in a high marginal tax bracket and Olivia is in a low
marginal tax bracket.
a.
Describe the elements that must be included in a partnership agreement in order for an allocation to have "economic effect."
b.
Discuss whether or not the MOG allocation would be permitted and provide your reasoning.
a.
For partnership allocations to meet the “economic effect” tests under the § 704(b) Regulations, a partnership agreement should provide that
(1) capital accounts will be maintained, (2) liquidating proceeds will be distributed according to capital account balances, and (3) any
partner with a deficit capital account balance will contribute cash to the partnership to eliminate the deficit.
b.
The MOG allocation will not be permitted. Though the partnership agreement may meet the “economic effect” tests under § 704, the
allocation does not produce pre-tax economic consequences to Molly and George (i.e., the allocation does not meet the “substantial”
requirement). Therefore, the allocations are not effective for tax purposes as they have no function other than the reduction of the partners’
combined tax liability.
105. On a corporate Form 1120, Schedule M-1 (or M-3) is used to reconcile book and tax income, and Schedule
M-2 reconciles retained earnings to the amounts shown on Schedule L. How are these reconciliations
accomplished on a partnership return? What additional information must be provided?
A partnership is not a taxpaying entity and does not report taxable income, per se. On Form 1065, the Analysis
of Income (Loss) schedule (page 5) accumulates the partnership’s equivalent of taxable income based on the
various income and deductions reported on the partnership’s Schedule K (page 4). This taxable income
equivalent is reconciled to book income on Schedules M-1 and M-3.
On Schedule L, the partnership reports partners’ capital using a “book” method, such as GAAP, “§ 704(b)
book,” or the tax basis, depending on the method the partnership uses for any financial reporting. On Schedule
M-2, the partnership reports partners’ capital using the same method it uses to prepare the partners’ capital
accounts on the partners’ Schedules K-1. If these methods differ, the partnership should provide a schedule
reconciling the two methods of reporting partners’ capital.
106. If a partnership receives tax-exempt income, this should not affect its partners’ basis in their partnership
interest. Do you agree with this statement? Explain.
Partnership income is intended to be subject to a single level of taxation. This is accomplished by: 1) flowing
the partnership’s income, gains, losses, and deductions through to be taxed by the partners, and 2) adjusting the
partners’ bases in their partnership interests upward and downward to account for those allocations.
A partner’s basis is adjusted for non-taxable income and non-deductible expenses as well as taxable amounts. If
the partners’ basis was not so adjusted, double taxation would arise. For example, if a partner’s share of
tax-exempt interest income was $5,000, the value of the partnership interest would theoretically increase by
$5,000. Because the partners’ basis in the partnership interest is increased by $5,000, the partner can sell the
interest without recognizing gain to the extent of that exempt income. If the basis were not so increased, the
exempt income would be taxed upon sale of the partnership interest.
107. What is the difference between a partner’s basis in the partnership interest and a partner’s capital account?
What are the purposes of these two amounts? Why are these amounts typically different?
The partner’s capital account balance is an accounting measure of the partner’s ownership interest in the entity.
Capital accounts are referenced in determining the partnership’s allocations of income, gains, losses,
deductions, and credits among the partners under § 704(b). In addition, liquidating distributions must be in
accordance with ending capital account balances under the substantial economic effect rules. The capital
account is reported on the partners’ Schedules K-1 and may be determined under GAAP, the § 704(b) book
method, or tax accounting rules.
A partner’s basis is the tax measure by which the partner’s taxable gain or loss is determined upon sale of the
interest or receipt of cash distributions from the partnership. Basis is also used as the measure for determining
whether the partner’s share of partnership losses can be deducted.
The partner’s initial basis (cost, gift, or inherited basis) is increased by the partner’s contributions to and
decreased by distributions from the partnership (including changes in the partner’s share of partnership
liabilities). In addition, basis is increased by the partner’s share of income and gains, and decreased by the
partner’s share of deductions and losses. Capital accounts are similarly adjusted, except the adjustments might
be based on fair market value determinations, and the partner’s share of partnership liabilities is not included.
These two amounts could only be the same if the partner shares in none of the partnership’s liabilities. The
partner’s basis includes the partner’s share of partnership liabilities. Partnership debts are not included in capital
accounts. Other situations that could cause differences between the two amounts include sale of an interest, or
death of a partner and transfer of the interest to a successor.
CHAPTER 11--PARTNERSHIPS: DISTRIBUTIONS,
TRANSFER OF INTERESTS, AND TERMINATIONS
Student: ___________________________________________________________________________
1. A cash distribution from a partnership to a partner is generally taxable to the partner.
True False
2. For Federal income tax purposes, a distribution from a partnership to a partner is treated the same as a
distribution from a C corporation to its shareholders.
True False
3. In a liquidating distribution, a partnership must distribute all of its property to all of its partners.
True False
4. A distribution can be “proportionate” (as defined for purposes of Subchapter K) even if only one partner
receives assets from the partnership.
True False
5. Loss will be recognized on any distribution from a partnership in which cash, unrealized receivables and/or
appreciated inventory are the only items distributed.
True False
6. Generally, no gain is recognized on a proportionate current or liquidating distribution of property even if the
fair market value of property distributed exceeds the partner’s basis in the partnership interest.
True False
7. In a proportionate nonliquidating distribution of cash and a capital asset, the partner recognizes gain to the
extent the amount of cash plus the fair market value of property distributed exceeds the partner’s basis in the
partnership interest.
True False
8. In a proportionate nonliquidating distribution, cash is deemed to be distributed first, followed by capital and §
1231 assets, and last, unrealized receivables and inventory.
True False
9. A gain will only arise on a distribution of cash that exceeds the partner’s basis in the partnership interest. For
this purpose, only cash, checks, and credit card charges are treated as cash.
True False
10. The ELF Partnership distributed $20,000 cash to Emma in a proportionate, nonliquidating distribution.
Emma’s basis in her partnership interest was $10,000 immediately before the distribution. As a result of the
distribution, Emma’s basis is reduced to $0 and she recognizes a $10,000 gain.
True False
11. Scott owns a 30% interest in the capital and profits of the SOS Partnership. Immediately before he receives
a proportionate nonliquidating distribution from SOS, the basis of his partnership interest is $40,000. The
distribution consists of $30,000 in cash and land with a fair market value of $80,000. SOS’s adjusted basis in
the land immediately before the distribution is $50,000. As a result of the distribution, Scott recognizes no gain
or loss and his basis in the land is $10,000.
True False
12. Randi owns a 40% interest in the capital and profits of the RAY Partnership. Immediately before she
receives a proportionate nonliquidating distribution from RAY, the basis for her partnership interest is $60,000.
The distribution consists of $45,000 in cash and land with a fair market value of $72,000. RAY’s adjusted basis
in the land immediately before the distribution is $36,000. As a result of the distribution, Randi recognizes a
gain of $21,000.
True False
13. Lori, a partner in the JKL partnership, received a proportionate nonliquidating distribution of $10,000 cash,
unrealized receivables with a basis of $0 and a fair market value of $15,000, and land with a basis of $6,000 and
a fair market value of $10,000. Her basis in the partnership interest immediately before the distributions was
$14,000. She will recognize $0 gain on the distribution, and her basis in the receivables and land will be $0 and
$4,000 respectively.
True False
14. Matt, a partner in the MB Partnership, receives a proportionate, nonliquidating distribution of property
having a fair market value of $16,000 and a partnership basis of $23,000. Matt’s basis in the partnership is
$10,000 before the distribution. In this situation, Matt will recognize no gain or loss. He will take a $10,000
basis in the property, and his basis in the partnership interest is reduced to zero.
True False
15. Tim and Darby are equal partners in the TD Partnership. Partnership income for the year is $60,000. Tim
needs cash in order to pay tax on his share of the partnership income, but Darby wants to leave the cash in the
partnership for expansion. If the partners agree, it is acceptable for TD to distribute $8,000 to Tim, and no cash
or other property to Darby.
True False
16. Marcie is a 40% member of the M&A LLC. Her basis is $10,000 immediately before the LLC distributes to
her $30,000 of cash and land (basis to the LLC of $20,000 and fair market value of $25,000). As a result of the
proportionate, nonliquidating distribution, Marcie recognizes a gain of $20,000 and her basis in the land is $0.
True False
17. The BAM Partnership distributed the following assets to partner Barbie in a proportionate non-liquidating
distribution: $10,000 cash, land parcel A (basis of $5,000, fair market value of $30,000) and land parcel B
(basis of $25,000, fair market value of $30,000). Barbie’s basis in her partnership interest was $40,000
immediately before the distribution. Barbie will allocate a basis of $15,000 each to the two land parcels, and her
basis in her partnership interest will be reduced to $0.
True False
18. In a proportionate liquidating distribution, RST Partnership distributes to partner Riley cash of $30,000,
accounts receivable (basis of $0, fair market value of $40,000), and land (basis of $65,000, fair market value of
$50,000). Riley’s basis was $40,000 before the distribution. On the liquidation, Riley recognizes a gain of $0,
and her basis is $10,000 in the land and $0 in the accounts receivable.
True False
19. In a proportionate liquidating distribution, WYX Partnership distributes to partner William cash of $40,000,
cash basis accounts receivable (basis of $0, fair market value of $10,000), and land (basis of $30,000, fair
market value of $50,000). William’s basis was $80,000 before the distribution. On the liquidation, William
recognizes a $20,000 gain, and he takes a basis of $10,000 in the accounts receivable, and $50,000 in the land.
True False
20. Zach’s partnership interest basis is $100,000. Zach receives a proportionate, liquidating distribution from a
liquidating partnership of $50,000 cash and inventory having a basis of $20,000 to the partnership and a fair
market value of $30,000. Zach assigns a basis of $20,000 to the inventory and recognizes a $30,000 loss.
True False
21. Carlos receives a proportionate liquidating distribution consisting of $8,000 cash and inventory with a basis
to the partnership of $5,000 and a fair market value of $6,000. His basis in his partnership interest was $15,000
immediately before the distribution. Carlos assigns a basis of $7,000 to the inventory, and recognizes no gain or
loss.
True False
22. The JIH Partnership distributed the following assets to partner James in a proportionate liquidating
distribution in which the partnership also liquidated: $25,000 cash, land parcel A (basis of $5,000, fair market
value of $30,000) and land parcel B (basis of $5,000, fair market value of $15,000). James’s basis in his
partnership interest was $85,000 immediately before the distribution. James will allocate bases of $40,000 to
parcel A and $20,000 to parcel B, and he will have no remaining basis in his partnership interest.
True False
23. In a proportionate liquidating distribution in which the partnership is also liquidated, Ralph received cash of
$30,000, accounts receivable (basis of $0, fair market value of $20,000), and equipment (basis of $0, fair
market value of $10,000). Immediately before the distribution, Ralph’s basis in the partnership interest was
$40,000. Ralph realizes and recognizes a loss of $10,000, and his basis is $0 in both the accounts receivable and
the equipment.
True False
24. Several years ago, the Jaymo Partnership purchased 2,000 shares of ABCO stock (publicly traded) for
$40,000; the stock now has a fair market value of $90,000. If this stock is distributed to Jason in liquidation of
his 30% partnership interest, it is treated as a cash distribution of $75,000 and a property distribution of
$15,000. Assume Jaymo owns no other securities.
True False
25. Normally a distribution of property from a partnership does not result in gain recognition. However, a
distribution of marketable securities may be treated, in part, as a distribution of cash that could result in gain
recognition.
True False
26. Mark contributed property to the MDB Partnership in 2009. At the time of the contribution, the basis in the
property was $40,000 and its value was $50,000. In 2013, MDB distributed that property to partner Dara.
Because this is a distribution of precontribution gain property, MBD (the partnership) may be required to
recognize a gain that is allocated to all of the partners.
True False
27. Generally, a distribution of property does not result in gain to a partner on either a current or liquidating
distribution. A situation where a gain may arise, however, is when a partner contributed appreciated property to
the partnership and that property is distributed back to the contributing partner within seven years of the
contribution.
True False
28. A disproportionate distribution arises when the partnership distributes a share of partnership hot assets to
one or more partners that is not the same as the partner’s ownership interest in the partnership.
True False
29. A payment to a retiring general partner for his or her share of goodwill of a partnership in which capital is
not a material income-producing factor is classified as a § 736(a) income payment and results in ordinary
income to the retiring partner and a current deduction to the partnership, as long as the goodwill payment is
provided for in the partnership agreement.
True False
30. The Crimson Partnership is a service provider. Its assets consist of unrealized receivables (basis of $0, fair
market value of $400,000), cash of $300,000, and land (basis of $200,000, fair market value of $300,000).
Assume 20% general partner Jana has a basis in her partnership interest of $100,000. If the ongoing partnership
distributes $200,000 of cash to Jana in liquidation of her interest in the partnership, she will recognize ordinary
income of $80,000 and a capital gain of $20,000.
True False
31. Taylor’s basis in his partnership interest is $140,000, including his $60,000 share of partnership debt. Sandy
buys Taylor’s partnership interest for $100,000 cash and she assumes Taylor’s $60,000 share of the
partnership’s debt. If the partnership owns no hot assets, Taylor will recognize a capital loss of $40,000.
True False
32. Beth sells her 25% partnership interest to Katie for $50,000 cash on July 1 of the current tax year. Katie also
assumed Beth’s share of the partnership’s liabilities. Beth’s basis in her partnership interest at the beginning of
the year was $40,000, including a $15,000 share of partnership liabilities. The partnership’s income for the
entire year was $100,000, and Beth’s share of partnership debt was $10,000 as of the date she sold the
partnership interest. Assume the partnership has no hot assets and that its income is earned evenly throughout
the year. Beth recognizes a gain of $12,500 on the sale.
True False
33. Nick sells his 25% interest in the LMNO Partnership to new partner Katrina for $57,500. The partnership’s
assets consist of cash ($100,000), land (basis of $90,000, fair market value of $70,000), and inventory (basis of
$40,000, fair market value of $60,000). Nick’s basis in his partnership interest was $57,500. On the sale, Nick
will recognize ordinary income of $5,000 and a capital loss of $5,000.
True False
34. A partnership has accounts receivable with a basis of $0 and a fair market value of $30,000 and depreciation
recapture potential of $20,000. All other assets of the partnership are either cash, capital assets, or § 1231 assets.
If a purchaser acquires a 40% interest in the partnership from another partner, the selling partner will be
required to recognize ordinary income of $12,000.
True False
35. If a partnership incorporates, it is always deemed to first distribute all of its assets and liabilities to the
partners in complete liquidation. Then the partners are deemed to contribute those assets to the new corporation
(with the corporation assuming the related liabilities) in a transaction that qualifies under § 351.
True False
36. In the year a donor gives a partnership interest to a donee, their share of the partnership’s income is prorated
between the donor and donee.
True False
37. A partnership is required to make a downward adjustment to the basis of its assets if a partnership interest is
sold and if the total decline in value of partnership assets is more than $250,000, even if a § 754 election is not
in effect.
True False
38. A § 754 election is made for a tax year in which the partner recognizes gain or loss on a distribution from
the partnership or the distributee partner’s basis in distributed property is increased or decreased from the inside
basis the partnership held in those assets. The election is made by the partnership each year in which it is
necessary to adjust a partner’s share of the inside basis of partnership assets. In a year in which an unfavorable
result would arise, the partnership can forego making the election.
True False
39. Jeremy sold his 40% interest in the HIJ Partnership to Ashley for $400,000. The inside basis of all
partnership assets was $600,000 at the time of the sale. If the partnership makes a § 754 election, it will record a
$160,000 step-up in the basis of the partnership assets, and the step-up will be attributed solely to Ashley.
True False
40. The MBA Partnership makes a § 736(b) cash payment of $20,000 to partner Amanda in liquidation of her
interest in the partnership. The partnership owns no hot assets. Amanda’s basis in her partnership interest before
the distribution was $50,000. If the partnership has a § 754 election in effect, it will record a $30,000 decrease
in its inside basis in partnership assets, affecting all the remaining partners in the partnership.
True False
41. Bob received a proportionate nonliquidating distribution of land from the BZ Partnership. The land had a
fair market value of $15,000 and a basis to the partnership of $10,000. The land was held for investment
purposes by the partnership. Bob’s basis in his partnership interest immediately before the distribution was
$6,000. If the partnership has a § 754 election in effect, it will record a $4,000 step-down in the basis of
remaining assets, and the step-down will be attributed to all partners in the partnership.
True False
42. A partnership continues in existence unless one of the following happens: 1) all assets are distributed to the
partners in liquidation of the partnership, or 2) a majority of the partners vote to adopt a plan of liquidation of
the partnership.
True False
43. Rex and Scott operate a law practice in partnership form. Because Rex and Scott are brothers, the
partnership is subject to the family partnership income reallocation rules.
True False
44. A limited liability company generally provides limited liability for those owners that are not active in the
management of the LLC but requires owner-managers of the LLC to have unlimited personal liability for LLC
debts.
True False
45. Dan receives a proportionate nonliquidating distribution when the basis of his partnership interest is
$30,000. The distribution consists of $10,000 in cash and property with an adjusted basis to the partnership of
$24,000 and a fair market value of $26,500. Dan's basis in the noncash property is:
A. $26,500.
B. $24,000.
C. $20,000.
D. $10,000.
E. None of the above.
46. At the beginning of the year, Elsie’s basis in the E&G Partnership interest is $90,000. She receives a
proportionate nonliquidating distribution from the partnership consisting of $10,000 of cash, unrealized
accounts receivable (basis of $0, fair market value $40,000), and land (basis of $30,000, fair market value of
$50,000). After the distribution, Elsie’s bases in the accounts receivable, land, and partnership interest are:
A. $0; $30,000; and $50,000.
B. $0; $50,000; and $30,000.
C. $40,000; $30,000; and $10,000.
D. $40,000; $40,000; and $0.
E. None of the above.
47. Megan’s basis was $120,000 in the MYP Partnership interest just before she received a proportionate
nonliquidating distribution consisting of land held for investment (basis of $100,000, fair market value of
$130,000) and inventory (basis of $80,000, fair market value of $70,000). After the distribution, Megan’s bases
in the land and inventory are, respectively:
A. $100,000 (land) and $20,000 (inventory).
B. $120,000 (land) and $0 (inventory).
C. $50,000 (land) and $70,000 (inventory).
D. $40,000 (land) and $80,000 (inventory).
E. None of the above.
48. Mark receives a proportionate nonliquidating distribution. At the beginning of the partnership year, the basis
of his partnership interest is $100,000. During the year, he received a cash distribution of $40,000 and a
property distribution (basis of $30,000, fair market value of $25,000). In addition, Mark’s share of partnership
liabilities was reduced by $10,000 during the year. How much gain or loss does Mark recognize; what is his
basis in the property he received; and what is his remaining basis in the partnership interest?
A. $25,000 loss; $25,000 basis in property; $0 remaining basis.
B. $30,000 loss; $30,000 basis in property; $0 remaining basis.
C. $0 gain or loss; $25,000 basis in property; $25,000 remaining basis.
D. $0 gain or loss; $30,000 basis in property; $20,000 remaining basis.
E. $0 gain or loss; $20,000 basis in property; $30,000 remaining basis.
49. Mack has a basis in a partnership interest of $200,000, including his share of partnership debt. At the end
of the current year, the partnership distributed to Mack, in a proportionate nonliquidating distribution, cash of
$20,000, inventory (basis to the partnership of $30,000 and fair market value of $40,000), and land (basis to the
partnership of $40,000 and fair market value of $42,000). In addition, Mack’s share of partnership debt
decreased by $12,000 during the year. What basis does Mack take in the inventory and land and in the
partnership interest (including debt share) following the distribution?
A. $30,000 basis in inventory; $40,000 basis in land, $98,000 basis in partnership.
B. $30,000 basis in inventory; $42,000 basis in land, $110,000 basis in partnership.
C. $40,000 basis in inventory; $40,000 basis in land, $86,000 basis in partnership.
D. $40,000 basis in inventory; $42,000 basis in land, $98,000 basis in partnership.
E. $40,000 basis in inventory; $42,000 basis in land, $110,000 basis in partnership.
50. Frank receives a proportionate nonliquidating distribution from the AEF Partnership. The distribution
consists of $10,000 cash and property (adjusted basis to the partnership of $54,000 and fair market value of
$60,000). Immediately before the distribution, Frank’s adjusted basis in the partnership interest was $50,000.
His basis in the noncash property received is:
A. $0.
B. $40,000.
C. $54,000.
D. $60,000.
E. None of the above.
51. Alyce owns a 30% interest in a continuing partnership. The partnership distributes a $35,000 year-end cash
payment to Alyce. In a proportionate nonliquidating distribution, the partnership also distributed property (basis
of $20,000, fair market value of $30,000) to Alyce. Immediately before the distributions of cash and property,
Alyce’s basis in the partnership interest was $60,000. As a result of the distribution, Alyce recognizes:
A. No gain or loss.
B. Ordinary loss of $5,000.
C. Capital loss of $5,000.
D. Ordinary gain of $5,000.
E. Capital gain of $5,000.
52. Catherine’s basis was $50,000 in the CAR Partnership just before she received a proportionate
nonliquidating distribution consisting of land held for investment with a basis to CAR of $40,000 (value of
$60,000), and inventory with a basis of $40,000 (value of $40,000). After the distribution, Catherine’s bases in
the land and inventory are:
A. $40,000 (land); $40,000 (inventory).
B. $40,000 (land); $10,000 (inventory).
C. $10,000 (land); $40,000 (inventory).
D. $25,000 (land); $25,000 (inventory).
E. None of these statements is correct.
53. Misha receives a proportionate nonliquidating distribution when the basis of her partnership interest is
$60,000. The distribution consists of $80,000 cash and inventory (adjusted basis to the partnership of $10,000,
fair market value of $20,000). How much gain or loss does Misha recognize, and what is her basis in the
distributed inventory and in her partnership interest following the distribution?
A. $0 gain or loss; $10,000 basis in inventory; $0 basis in partnership interest.
B. $0 gain or loss; $20,000 basis in inventory; $50,000 basis in partnership interest.
C. $20,000 capital gain; $0 basis in inventory; $0 basis in partnership interest.
D. $20,000 capital gain; $10,000 basis in inventory; $0 basis in partnership interest.
E. $20,000 ordinary income; $0 basis in inventory; $20,000 basis in partnership interest.
54. Nicky’s basis in her partnership interest was $150,000, including her $40,000 share of partnership liabilities.
The partnership decides to liquidate, and after repaying all liabilities, distributes all remaining assets
proportionately to the partners. Nicky receives $30,000 cash and accounts receivable with a $50,000 basis and a
$48,000 fair market value to the partnership. What gain or loss does Nicky recognize, and what is her basis in
the accounts receivable?
A. $70,000 loss; $50,000 basis.
B. $30,000 loss; $50,000 basis.
C. $32,000 loss; $48,000 basis.
D. $72,000 loss; $48,000 basis.
E. $0 loss; $80,000 basis.
55. Anthony’s basis in the WAM Partnership interest was $200,000 just before he received a proportionate
liquidating distribution consisting of investment land (basis of $90,000, fair market value of $100,000), and
inventory (basis of $30,000, fair market value of $70,000). After the distribution, Anthony’s recognized gain or
loss and his basis in the land and inventory are:
A. $80,000 loss; $90,000 (land); $30,000 (inventory).
B. $70,000 loss; $100,000 (land); $30,000 (inventory).
C. $30,000 loss; $100,000 (land); $70,000 (inventory).
D. $0 gain or loss; $170,000 (land); $30,000 (inventory).
E. None of the above.
56. Beth has an outside basis of $100,000 in the BTDE Partnership as of December 31 of the current year. On
that date the partnership liquidates and distributes to Beth a proportionate distribution of $50,000 cash and
inventory with an inside basis to the partnership of $10,000 and a fair market value of $16,000. In addition,
Beth receives an antique desk (not inventory) which has an inside basis and fair market value of $0 and $5,000,
respectively. None of the distribution is for partnership goodwill. How much gain or loss will Beth recognize on
the distribution, and what basis will she take in the desk?
A. $40,000 loss; $0 basis.
B. $35,000 loss; $5,000 basis.
C. $0 gain or loss; $5,000 basis.
D. $0 gain or loss; $40,000 basis.
E. None of the above.
57. Landis received $90,000 cash and a capital asset (basis of $50,000, fair market value of $60,000) in a
proportionate liquidating distribution. His basis in his partnership interest was $120,000 prior to the distribution.
How much gain or loss does Landis recognize and what is his basis in the asset received?
A. $0 gain or loss; $30,000 basis.
B. $0 gain or loss; $50,000 basis.
C. $0 gain or loss; $60,000 basis.
D. $20,000 gain; $50,000 basis.
E. $30,000 gain; $60,000 basis.
58. Jonathon owns a one-third interest in a liquidating partnership. Immediately before the liquidation,
Jonathon’s basis in the partnership interest is $60,000. The partnership distributes cash of $32,000 and two
parcels of land (each with a fair market value of $10,000). Parcel A has a basis of $2,000 to the partnership and
Parcel B has a basis of $6,000. Jonathon’s basis in the two parcels of land is:
A. Parcel A, $2,000; Parcel B, $6,000.
B. Parcel A, $7,000; Parcel B, $21,000.
C. Parcel A, $10,000; Parcel B, $10,000.
D. Parcel A, $14,000; Parcel B, $14,000.
E. Parcel A, $15,000; Parcel B, $45,000.
59. Michelle receives a proportionate liquidating distribution when the basis of her partnership interest is
$50,000. The distribution consists of $58,000 cash and noninventory property (adjusted basis to the partnership
of $10,000 and fair market value of $12,000). The partnership has no hot assets. How much gain or loss does
Michelle recognize, and what is her basis in the distributed property?
A. $0 gain or loss; $0 basis in property.
B. $0 gain or loss; $50,000 basis in property.
C. $8,000 ordinary income; $0 basis in property.
D. $8,000 capital gain; $10,000 basis in property.
E. $8,000 capital gain; $0 basis in property.
60. Suzy owns a 30% interest in the JSD LLC. In liquidation of the entity, Suzy receives a proportionate
distribution of $30,000 cash, inventory (basis of $16,000, fair market value of $18,000), and land (basis of
$25,000, fair market value of $30,000). Suzy’s basis in the entity immediately before the distribution was
$80,000. As a result of the distribution, what is Suzy’s basis in the inventory and land, and how much gain or
loss does she recognize?
A. $0 basis in inventory; $25,000 basis in land; $0 gain or loss.
B. $16,000 basis in inventory; $34,000 basis in land; $0 gain or loss.
C. $16,000 basis in inventory; $25,000 basis in land; $9,000 loss.
D. $18,000 basis in inventory; $32,000 basis in land; $0 gain.
E. $25,000 basis in inventory; $25,000 basis in land; $0 gain or loss.
61. In a proportionate liquidating distribution, Sam receives a distribution of $30,000 cash, accounts receivable
(basis of $0, fair market value of $50,000), and land (basis of $20,000, fair market value of $50,000). In
addition, the partnership repays all liabilities, of which Sam’s share was $40,000. Sam’s basis in the entity
immediately before the distribution was $120,000. As a result of the distribution, what is Sam’s basis in the
accounts receivable and land, and how much gain or loss does he recognize?
A. $0 basis in accounts receivable; $50,000 basis in land; $0 gain or loss.
B. $0 basis in accounts receivable; $90,000 basis in land; $0 gain or loss.
C. $50,000 basis in accounts receivable; $40,000 basis in land; $0 gain or loss.
D. $50,000 basis in accounts receivable; $50,000 basis in land; $50,000 gain.
E. $0 basis in accounts receivable; $70,000 basis in land; $30,000 loss.
62. In a proportionate liquidating distribution, Ashleigh receives a distribution of $30,000 cash, accounts
receivable (basis of $0, fair market value of $40,000), and land (basis of $40,000, fair market value of $50,000).
In addition, the partnership repays all liabilities, of which Ashleigh’s share was $70,000. Ashleigh’s basis in the
entity immediately before the distribution was $60,000. As a result of the distribution, what is Ashleigh’s basis
in the accounts receivable and land, and how much gain or loss does she recognize?
A. $0 basis in accounts receivable; $0 basis in land; $40,000 gain.
B. $0 basis in accounts receivable; $30,000 basis in land; $0 gain or loss.
C. $0 basis in accounts receivable; $40,000 basis in land; $0 gain or loss.
D. $40,000 basis in accounts receivable; $20,000 basis in land; $0 gain.
E. $40,000 basis in accounts receivable; $20,000 basis in land; $100,000 gain.
63. In a proportionate liquidating distribution, Sara receives a distribution of $40,000 cash, accounts receivable
(basis of $0, fair market value of $30,000), and inventory (basis of $50,000, fair market value of $60,000).
Sara’s basis in the entity immediately before the distribution was $120,000. As a result of the distribution, what
is Sara’s basis in the accounts receivable and inventory, and how much gain or loss does she recognize?
A. $0 basis in accounts receivable; $50,000 basis in inventory; $30,000 loss.
B. $0 basis in accounts receivable; $80,000 basis in inventory; $0 gain or loss.
C. $40,000 basis in accounts receivable; $40,000 basis in inventory; $0 gain or loss.
D. $30,000 basis in accounts receivable; $50,000 basis in inventory; $30,000 loss.
E. $30,000 basis in accounts receivable; $60,000 basis in inventory; $10,000 gain.
64. Which of the following statements correctly reflects the rules regarding proportionate liquidating
distributions?
A. Relief of liabilities is treated as a distribution of cash but only to the extent that the cash distribution does not
exceed the partner’s basis in the partnership interest.
B. A partner’s basis in distributed unrealized receivables is the lesser of the partnership’s basis in the
receivables or their fair market value.
C. The basis of unrealized receivables cannot be stepped up to their fair market value unless the partner has
adequate unabsorbed basis.
D. Assets are deemed distributed in the following order: cash, unrealized receivables and inventory and finally,
capital assets.
E. The partner can recognize gain, but not loss, on a proportionate liquidating distribution.
65. Which of the following distributions would never result in gain recognition to the recipient partner?
A. A distribution of cash that follows a contribution of appreciated property to the partnership.
B. A distribution of a slightly appreciated marketable security.
C. A distribution of property to a partner who, three years ago, contributed other property with a built-in gain.
D. A distribution to a second partner of property contributed by the first partner two years ago.
E. A proportionate distribution of inventory property.
66. Last year, Darby contributed land (basis of $60,000, fair market value of $80,000) to the Seagull LLC in
exchange for a 25% interest in the LLC. In the current year, the LLC distributes the land (now worth $82,000)
to Shelby, who is also a 25% owner. Immediately prior to the distribution, Darby’s basis in the LLC was
$70,000, while Shelby’s basis in the LLC was $110,000. How much gain or loss must be recognized and by
whom? What is Shelby’s basis in the property she receives and Darby’s basis in her partnership interest
following the distribution?
A. No gain or loss; Shelby’s basis in the property is $80,000; Darby’s basis in interest is $70,000.
B. $20,000 gain recognized by Darby; Shelby’s basis in the property is $80,000; Darby’s basis in interest is
$90,000.
C. $22,000 gain recognized by Darby; Shelby’s basis in the property is $82,000; Darby’s basis in interest is
$92,000.
D. $20,000 gain recognized by Shelby; Shelby’s basis in the property is $80,000; Darby’s basis in interest is
$90,000.
E. $22,000 gain recognized by Shelby; Shelby’s basis in the property is $82,000; Darby’s basis in interest is
$92,000.
67. Last year, Miguel contributed nondepreciable property with a basis of $50,000 and a fair market value of
$75,000 to the Starling Partnership in exchange for a 25% interest in the partnership. In the current year, he
receives a nonliquidating distribution from the partnership of other property with a basis to the partnership of
$50,000 and a fair market value of $62,000. The basis in his partnership interest at the time of the distribution
was $60,000. How much gain or loss does Miguel recognize on the distribution? (Assume no other distributions
have been made to Miguel, the property he originally contributed is still owned by the partnership, and this is
not a disguised sale transaction.)
A. $0 gain or loss.
B. $2,000 loss.
C. $2,000 gain.
D. $8,000 gain.
E. $10,000 gain.
68. Which of the following is not typically considered to be a “hot asset?”
A. Accounts receivable of a cash basis partnership.
B. Inventory with a basis of $16,000 and a fair market value of $15,000.
C. Depreciation recapture potential.
D. Land held for development.
E. All of the above are typically considered to be “hot assets.”
69. Tom, Tina, Tatum, and Terry are equal owners in the 4-Ts LLC, a cash basis service entity. 4-Ts has
unrealized receivables of $400,000 (basis of $0), and no other hot assets. A goodwill payment of $50,000 per
partner is provided for in the LLC’s operating agreement. If 4-Ts distributes cash of $300,000 to Tom in
liquidation of his LLC interest, which of the following statements is correct?
A. This is a proportionate distribution with respect to hot assets.
B. The $50,000 payment that relates to LLC goodwill cannot be deducted by the LLC.
C. The partnership will terminate.
D. The $150,000 § 736(a) payment will result in a capital gain to Tom.
E. The $200,000 § 736(b) payment will be taxed to Tom as ordinary income.
70. The December 31, 2013, balance sheet of the RST General Partnership reads as follows.
Cash
Receivables
Capital and § 1231 assets
Total
Adjusted
Basis
$ 65,000
–0–
55,000
$120,000
FMV
$ 65,000
7,500
100,000
$172,500
Roy, capital
Sue, capital
Ted, capital
Total
$ 40,000
40,000
40,000
$120,000
$ 57,500
57,500
57,500
$172,500
The partners share equally in partnership capital, income, gain, loss, deduction and credit. Ted’s adjusted basis for his partnership interest is $40,000.
On December 31, 2013, he retires from the partnership, receiving a $60,000 cash payment in liquidation of his interest. The partnership agreement
states that $2,500 of the payment is for goodwill. Which of the following statements about this distribution is false?
A. If capital is NOT a material income-producing factor to the partnership, the § 736(a) payment will be $2,500.
B. If capital IS a material income-producing factor, the entire $60,000 payment will be a § 736(b) property
payment.
C. The payment for Ted’s share of goodwill will create $2,500 of ordinary income to him.
D. The partnership can deduct any amount that is a § 736(a) payment because it will be determined without
regard to partnership profits.
E. All statements are false.
71. The December 31, 2013, balance sheet of GST Services, LLP reads as follows:
Cash
Receivables
Capital assets
Total
George, capital
Sue, capital
Tom, capital
Total
Adjusted
Basis
$300,000
–0–
120,000
$420,000
$140,000
140,000
140,000
$420,000
FMV
$300,000
150,000
150,000
$600,000
$200,000
200,000
200,000
$600,000
The partners share equally in partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the
partnership, and all partners are active in the business. On December 31, 2013, general partner Sue receives a distribution of $200,000 cash in
liquidation of her partnership interest under § 736. Sue’s outside basis for the partnership interest immediately before the distribution is $150,000.
(Her basis does not correspond to her capital account because she purchased the interest a few years ago at a $10,000 premium.) How much is Sue’s
gain or loss on the distribution and what is its character?
A. $50,000 ordinary income.
B. $40,000 ordinary income; $10,000 capital gain.
C. $40,000 capital gain; $10,000 ordinary income.
D. $50,000 capital gain.
E. None of the above.
72. Which of the following statements is true regarding the sale of a partnership interest?
A. The selling partner’s share of partnership liabilities is disregarded in determining the proceeds from the sale
of a partnership interest.
B. For purposes of computing the selling partner’s gain or loss, the partner’s basis in the partnership interest is
determined as of the last day of the partnership tax year ending before the year in which the interest is sold.
C. If a partner sells an interest in a partnership, income related to that interest for the year of the sale is allocated
to the purchaser.
D. The selling partner could be required to report both ordinary income and a capital loss on sale of the
partnership interest.
E. The partner’s share of partnership “hot assets” is disregarded in determining the character of the partner’s
gain on the sale of the partnership interest.
73. Nicholas is a 25% owner in the DDBN LLC (a calendar year entity). At the end of the last tax year,
Nicholas’s basis in his interest was $50,000, including his $20,000 share of LLC liabilities. On July 1 of the
current tax year, Nicholas sells his LLC interest to Anna for $80,000 cash. In addition, Anna assumes
Nicholas’s share of LLC liabilities, which, at that date, was $15,000. During the current tax year, DDBN’s
taxable income is $120,000 (earned evenly during the year). Nicholas’s share of the LLC’s unrealized
receivables is valued at $6,000 ($0 basis). At the sale date, what is Nicholas’s basis in his LLC interest, how
much gain or loss must he recognize, and what is the character of the gain or loss?
A. $45,000 basis; $6,000 ordinary income; $44,000 capital gain.
B. $60,000 basis; $6,000 ordinary income; $29,000 capital gain.
C. $60,000 basis; $35,000 capital gain.
D. $75,000 basis; $0 ordinary income; $20,000 capital gain.
E. $75,000 basis; $6,000 ordinary income; $14,000 capital gain.
74. The BLM LLC’s balance sheet on August 31 of the current year is as follows.
Cash
Receivables
Capital assets
Nonrecourse debt
Barney, capital
Lillie, capital
Marshall, capital
Adjusted
Basis
$ 60,000
–0–
90,000
$150,000
FMV
$ 60,000
150,000
300,000
$510,000
$ 90,000
20,000
20,000
20,000
$150,000
$ 90,000
140,000
140,000
140,000
$510,000
The nonrecourse debt is shared equally among the LLC members. On that date, Lillie sells her one-third interest to Robyn for $170,000, including
cash and relief of Lillie’s share of the nonrecourse debt. Lillie’s outside basis for her interest in the LLC is $50,000, including her share of the LLC’s
debt. How much capital gain and/or ordinary income will Lillie recognize on the sale?
A. $100,000 capital gain; $50,000 ordinary income.
B. $120,000 capital gain; $0 ordinary income.
C. $150,000 capital gain; $0 ordinary income.
D. $70,000 capital gain; $50,000 ordinary income.
E. None of the above.
75. Which of the following statements about the transfer of a partnership interest is not true?
A. The seller’s adjusted basis for the partnership interest is increased by the seller’s share of undistributed
partnership income (or reduced by partnership loss) for the portion of the partnership’s taxable year ending on
the date of the sale.
B. The partnership taxable year generally does not close with respect to a partner who transfers a partnership
interest at death; all amounts are allocated to the successor.
C. The amount realized on the sale of a partnership interest is the sum of any money and the fair market value
of any property received for the interest, plus the selling partner’s share of partnership liabilities under § 752.
D. With respect to a transfer of a partnership interest by gift, all partnership gain, loss, credit, etc., items are
allocated between the donor and the donee.
E. All of the above are true statements.
76. Brittany, Jennifer, and Daniel are equal partners in the BJD Partnership. The partnership balance sheet reads
as follows on December 31 of the current year.
Cash
Unrealized receivables
Land
Total
Adjusted
Basis
$ 75,000
–0–
45,000
$120,000
FMV
$ 75,000
51,000
63,000
$189,000
Brittany, capital
Jennifer, capital
Daniel, capital
Total
$ 40,000
40,000
40,000
$120,000
$ 63,000
63,000
63,000
$189,000
Partner Daniel has an adjusted basis of $40,000 for his partnership interest. If Daniel sells his entire partnership interest to new partner Amber for
$73,000 cash, how much can the partnership step-up the basis of Amber’s share of partnership assets under §§ 754 and 743(b)?
A. $6,000.
B. $17,000.
C. $23,000.
D. $33,000.
E. None of the above.
77. Partner Jordan received a distribution of $90,000 cash from the JKL Partnership in complete liquidation of
his partnership interest. If Jordan’s outside basis immediately before the distribution was $80,000, and if the
partnership has made (and not revoked) a § 754 election in a prior year, which of the following statements is
true? (Assume the partnership owns no “hot assets.”)
A. The partnership will step-down the basis of its assets by $10,000.
B. The partnership will step-up the basis of its assets by $10,000.
C. Jordan will recognize a $10,000 capital gain on the distribution.
D. Both a. and c. are true.
E. Both b. and c. are true.
78. The RST Partnership makes a proportionate distribution of its assets to Ryan, in complete liquidation of his
partnership interest. The distribution consists of $40,000 in cash and capital assets with a basis to the
partnership of $30,000 and a fair market value of $48,000. None of the payment is for partnership goodwill. At
the time of the distribution, Ryan’s partnership basis is $45,000 and the partnership has no liabilities and no
“hot assets.” If the partnership makes an optional basis adjustment election on a timely filed return, it
recognizes:
A. Capital gain of $25,000 and increases the basis of its remaining assets by $12,500.
B. Capital loss of $5,000 and decreases the basis of its remaining assets by $5,000.
C. No gain or loss and increases the basis of its remaining assets by $25,000.
D. No gain or loss and decreases the basis of its remaining assets by $58,000.
E. None of the above.
79. Cynthia sells her 1/3 interest in the CAR Partnership to Brandon for $95,000 cash. On the date of sale, the
partnership balance sheet and agreed-upon fair market values were as follows:
Cash
Receivables
Land
Total
Adjusted
Basis
$40,000
–0–
50,000
$90,000
FMV
$ 40,000
60,000
125,000
$225,000
Cynthia, capital
Arnold, capital
Ralph, capital
Total
$30,000
30,000
30,000
$90,000
$ 75,000
75,000
75,000
$225,000
If the partnership has a § 754 election in effect, the total “step-up” in basis of partnership assets that will be allocated to Brandon is:
A. $75,000.
B. $65,000.
C. $45,000.
D. $20,000.
E. $0.
80. A partnership may make an optional election to adjust the basis of its property on a distribution to a partner
which liquidates the partner’s entire interest in the partnership. If such an election is in effect, the partnership:
A. Generally applies the election to transfers that take place at any later date, unless the election is revoked.
B. Only adjusts the basis of its property for differences in basis between that of the partnership and a distributee
partner if a transferor-transferee situation arises within two years after the distribution.
C. Increases the basis of similar retained assets when a distributee partner takes a basis which is greater than the
partnership’s basis in these assets, assuming the partnership does not have any receivables or inventory.
D. Decreases the basis of similar retained assets when the distributee partner recognizes gain on the distribution.
E. All of the above.
81. Which of the following transactions will not result in termination of a partnership for Federal tax purposes?
A. The partnership is incorporated.
B. A 70% interest in partnership capital and profits is sold to a third party purchaser.
C. Cash is distributed in liquidation of a 60% partner’s interest in a five-partner partnership.
D. A 40% interest in partnership capital and profits is sold to the other partner in a two-partner partnership.
E. None of the above.
82. On December 31 of last year, Maria gave her daughter, Chelsea, a gift of a 25% interest in a partnership in
which capital is a material income-producing factor. For the current calendar year, the partnership’s ordinary
income was $100,000. Maria and Chelsea were the only partners, and there were no guaranteed payments.
Maria’s services performed for the partnership were worth $60,000, and Chelsea has never performed any
services. What is Maria’s distributive share of partnership income for the current year?
A. $60,000.
B. $75,000.
C. $90,000.
D. $100,000.
E. None of the above.
83. Which of the following statements, if any, about an LLC is false?
A. An LLC is usually taxed like a partnership.
B. “Members” of an LLC generally have limited personal liability for debts of the LLC, except for the
managing member who has unlimited liability for LLC debts.
C. “Members” of an LLC can participate in management of the LLC unless the member agrees not to
participate.
D. An LLC can specially allocate income items, as long as the substantial economic effect rules of § 704(b) are
followed.
E. None of the above statements is false.
84. George is planning to retire from the GDP LLC, where he is an active managing member owning a 60%
interest. Capital is not a material income-producing factor to GDP. The LLC can either redeem his interest
under § 736 or he can sell his interest to Dale, who currently owns a 20% interest. The LLC’s operating
agreement is silent regarding treatment of goodwill. As to George’s alternatives, which one of the following
statements is true?
A. Either the sale or the redemption would terminate the partnership.
B. Payments to George for his share of GDP’s goodwill would be treated the same for either a sale or
redemption.
C. George will report ordinary income related to his share of “hot assets” under either the sale or the redemption
scenario.
D. If GDP/Dale negotiate payments over several years, either an installment sale or a redemption over time
would result in the same tax situation to George.
E. All of the above statements are true.
85. Match the following statements with the best match from the choices below. Note: Choice L may be used
more than once.
1. Unrealized receivable
2. Liquidating
distribution
3. Nonqualified
distribution
4. Substantially appreciated
inventory
5. Inventory
6. Nonliquidating
distribution
7. Depreciation recapture
8. Disproportionate
distribution
9. Hot assets
10. Ordering rules
11. Optional adjustment
election
No correct match provided. ____
Cash, then inventory and unrealized
receivables, then other assets. ____
Ordinary income-producing items.
Fair market value exceeds 120% of basis.
Does not eliminate the partner’s interest in
the partnership.
Sometimes treated as an unrealized
receivable.
Any partnership assets other than cash,
capital, or § 1231 assets.
Cash basis accounts receivable, for
example.
Changes the partner’s or the partnership’s
ordinary income potential.
Terminates the partner’s interest in the
partnership.
Inside basis of partnership property can be
adjusted to reflect the purchase price paid.
____
____
____
____
____
____
____
____
____
86. Connie owns a one-third capital and profits interest in the calendar-year CDB Partnership. Her adjusted
basis for her partnership interest was $120,000 when she received a proportionate nonliquidating distribution of
the following assets:
Cash
Land held for investment
Partnership’s Basis in Asset
$140,000
30,000
a.
Calculate Connie’s recognized gain or loss on the distribution, if any.
b.
Calculate Connie’s basis in the land received.
c.
Calculate Connie’s basis for her partnership interest after the distribution.
Asset’s Fair Market Value
$140,000
60,000
87. Randy owns a one-fourth capital and profits interest in the calendar-year RUSR Partnership. His adjusted
basis for his partnership interest was $200,000 when he received a proportionate nonliquidating distribution of
the following assets:
Cash
Inventory
Partnership’s Basis in Asset
$120,000
60,000
a.
Calculate Randy’s recognized gain or loss on the distribution, if any. Explain.
b.
Calculate Randy’s basis in the inventory received.
c.
Calculate Randy’s basis for his partnership interest after the distribution.
Asset’s Fair Market Value
$120,000
90,000
88. Karli owns a 25% capital and profits interest in the calendar-year KJDV Partnership. Her adjusted basis for
her partnership interest on July 1 of the current year is $200,000. On that date, she receives a proportionate
nonliquidating distribution of the following assets:
Cash
Inventory
Land (held for investment)
Partnership’s Basis in Asset
$120,000
50,000
70,000
a.
Calculate Karli’s recognized gain or loss on the distribution, if any.
b.
Calculate Karli’s basis in the inventory received.
c.
Calculate Karli’s basis in land received. The land is a capital asset.
d.
Calculate Karli’s basis for her partnership interest after the distribution.
Asset’s Fair Market Value
$120,000
60,000
100,000
89. Melissa is a partner in a continuing partnership. At the end of the current year, the partnership makes a
proportionate, nonliquidating distribution to Melissa of $50,000 cash, inventory (basis of $22,000, fair market
value of $20,000), and land (basis of $30,000, fair market value of $60,000). Melissa’s basis in the partnership
interest was $90,000 before the distribution. What is Melissa’s basis in the inventory, land, and partnership
interest following the distribution?
90. In a proportionate nonliquidating distribution of his 30% interest in the MNO LLC, Neil received cash
($60,000), land (basis of $40,000 and value of $75,000), and unrealized receivables (basis of $0 and value of
$22,000). In addition, Neil is relieved of his $40,000 share of the LLC’s liabilities. Neil’s basis in MNO
(including his share of LLC liabilities) was $80,000 immediately prior to this distribution.
a.
How much gain or loss does Neil recognize on this distribution?
b.
What is Neil’s basis in the receivables and land he receives in the distribution?
c.
What is Neil’s basis in the LLC interest following the distribution?
91. In a proportionate liquidating distribution of his 40% interest in the RST LLC, Stuart received cash
($100,000), land (basis of $60,000 and value of $90,000), and unrealized receivables (basis of $0 and value of
$40,000). In addition, Stuart is relieved of his $80,000 share of the LLC’s liabilities. Stuart’s basis in RST
(including his share of LLC liabilities) was $200,000 immediately prior to this distribution.
a.
How much gain or loss does Stuart recognize on this distribution?
b.
What is Stuart’s basis in the receivables and land he receives in the distribution?
92. In a proportionate liquidating distribution in which the partnership is liquidated, Marcus received cash of
$60,000, inventory (basis of $10,000, fair market value of $12,000), and a capital asset (basis and fair market
value of $22,000). Immediately before the distribution, Marcus’s basis in the partnership interest was $100,000.
a.
How much gain or loss will Marcus recognize on the distribution?
b.
What is Marcus’s basis in the inventory and the capital asset?
93. In a proportionate liquidating distribution in which the partnership is liquidated, Bill received cash of
$120,000, inventory (basis of $6,000, fair market value of $8,000), and a capital asset (basis and fair market
value of $16,000). Immediately before the distribution, Bill’s basis in the partnership interest was $90,000.
a.
How much gain or loss will Bill recognize on the distribution?
b.
What is Bill’s basis in the inventory and the capital asset?
94. Josh has a 25% capital and profits interest in the calendar-year GDJ Partnership. His adjusted basis for his
partnership interest on October 15 of the current year is $300,000. On that date, the partnership liquidates and
makes a proportionate distribution of the following assets to Josh.
Cash
Inventory
Partnership’s Basis in Asset
$ 70,000
120,000
Asset’s Fair Market Value
$ 70,000
150,000
a.
Calculate Josh’s recognized gain or loss on the liquidating distribution, if any.
b.
How would your answer to a. change if the partnership also distributed a small parcel of land it had held for investment to Josh? Assume
the land has a $5,000 adjusted basis (FMV is $8,000) to the partnership.
95. The December 31, 2013, balance sheet of DBW, LLP, a service-providing partnership is as follows:
Cash
Receivables
Capital assets
Total
Adjusted
Basis
$180,000
–0–
90,000
$270,000
FMV
$180,000
60,000
120,000
$360,000
Dana, capital
Brooke, capital
Whitney, capital
Total
$ 90,000
90,000
90,000
$270,000
$120,000
120,000
120,000
$360,000
The partners share equally in partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the
partnership. On December 31, 2013, partner Dana (who is an active managing partner in the partnership) receives a distribution of $120,000 cash in
liquidation of her partnership interest under § 736. Dana’s outside basis for the partnership interest immediately before the distribution is $90,000.
How much is Dana’s gain or loss on the distribution and what is its character?
96. The December 31, 2013, balance sheet of the BCD LLP reads as follows.
Cash
Receivables
Capital assets
Total
Adjusted
Basis
$210,000
–0–
42,000
$252,000
FMV
$210,000
120,000
69,000
$399,000
Ben, capital
Christina, capital
Danielle, capital
Total
$ 84,000
84,000
84,000
$252,000
$133,000
133,000
133,000
$399,000
Each partner shares in 1/3 of the partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the
partnership. On December 31, 2013, general partner Christina receives a distribution of $140,000 cash in liquidation of her partnership interest under
§ 736. Nothing is stated in the partnership agreement about goodwill. Christina’s outside basis for the partnership interest immediately before the
distribution is $84,000.
How much is Christina’s recognized gain from the distribution and what is the character of the gain?
97. Susan is a one-fourth limited partner in the SJ Partnership in which capital is not a material
income-producing factor. Partnership assets consist of land (fair market value of $100,000, basis of $80,000),
accounts receivable (fair market value of $100,000, basis of $0) and cash of $200,000. SJ distributes $100,000
of the cash to Susan in liquidation of her interest. Susan’s basis in the partnership interest was $70,000
immediately before the distribution. How much gain or loss does Susan recognize and what is its character?
How much can the partnership deduct?
98. Jeremy is an active partner who owns a 30% interest in the JS LLP (in which capital is not a material
income-producing factor). Partnership assets consist of land (fair market value of $200,000, basis of $140,000),
accounts receivable (fair market value of $200,000, basis of $0), and cash of $400,000. JS distributes $220,000
of the cash to Jeremy in liquidation of his interest. In addition, Jeremy is relieved of his $40,000 share of the
LLP’s liabilities. The total payment includes $20,000 for Jeremy’s share of JS goodwill (for which the
agreement does not provide). Jeremy’s basis in the partnership interest (including his share of the partnership’s
liabilities) is $120,000 immediately before the distribution. How much gain or loss does Jeremy recognize and
what is its character? How much can the partnership deduct?
99. Serena owns a 40% interest in the RST LLP. Partnership assets consist of land (fair market value of
$100,000, basis of $80,000), accounts receivable (fair market value of $120,000, basis of $0), and cash of
$180,000. Serena sells her interest in RST to Jaclyn for cash of $140,000. In addition, Jaclyn assumes Serena’s
$40,000 share of the LLP’s liabilities. Serena’s basis in the partnership interest (including her share of the
partnership’s liabilities) is $120,000 immediately before the sale.
a.
How much gain or loss does Serena recognize and what is its character?
b.
What is Jaclyn’s basis in the partnership interest?
c.
If the LLP has a § 754 election in effect, how much is the adjustment and to which partner(s) is it allocated?
100. On August 31 of the current tax year, the balance sheet of the RBD General Partnership is as follows:
Cash
Receivables
Capital assets
Total
Adjusted
Basis
$150,000
–0–
600,000
$750,000
FMV
$150,000
90,000
660,000
$900,000
Nonrecourse debt
Rachel, capital
Barry, capital
Dale, capital
Total
$150,000
200,000
200,000
200,000
$750,000
$150,000
250,000
250,000
250,000
$900,000
On that date, Rachel sells her one-third partnership interest to Lisa for $300,000, including cash and relief of Rachel’s share of the nonrecourse debt.
The nonrecourse debt is shared equally among the partners. Rachel’s outside basis for her partnership interest is $250,000 (including her share of
partnership debt). How much capital gain and/or ordinary income will Rachel recognize on the sale?
101. Hannah sells her 25% interest in the HIJK Partnership to Alyssa for $120,000 cash. At the end of the year
prior to the sale, Hannah’s basis in HIJK was $70,000. The partnership allocates $15,000 of income to Hannah
for the portion of the year she was a partner. On the date of the sale, the partnership assets and the agreed fair
market values were as follows.
Cash
Accounts Receivable
Land
Total
Determine the amount and character of any gain that Hannah recognizes on the sale.
Adjusted
Basis
$100,000
–0–
240,000
$340,000
FMV
$100,000
80,000
220,000
$400,000
102. The December 31, 2013, balance sheet of the calendar-year JKL Partnership reads as follows.
Cash
Capital asset (nondepreciable)
Total
Adjusted
Basis
$24,000
33,000
$57,000
FMV
$ 24,000
105,000
$129,000
Jan, capital
Ken, capital
Laura, capital
Total
$19,000
19,000
19,000
$57,000
$ 43,000
43,000
43,000
$129,000
Each partner shares in 1/3 of the partnership capital, income, gain, loss, deduction and credit. On December 31, 2013, Jan sells her 1/3 partnership
interest to Jennifer for $43,000 cash. Assume the partnership makes a § 754 election for 2013.
a.
What is the amount of Jennifer’s “step-up” adjustment under § 743(b)?
b.
If the nondepreciable capital asset is sold the next year for $120,000, determine the amount of gain that Jennifer will recognize on her tax
return because of the sale.
103. Compare the different tax results (gains, losses, basis) that might arise for a partner in a proportionate
nonliquidating distribution vs. a proportionate liquidating distribution. Consider the general rules only.
104. Your client, Greg, transferred precontribution gain property to BIG LLC on December 31, 2013, for a 30%
interest.
a.
Describe two types of distributions that might result in some or all of this precontribution gain being recognized by Greg.
b.
In general terms, what is the purpose of these rules?
105. a.
When does a disproportionate distribution arise?
b.
When does a disproportionate distribution not arise?
c.
In general terms, what is the effect of a disproportionate distribution?
106. Cindy, a 20% general partner in the CDE Partnership, wants to retire and has approached the other partners
about having the partnership buy her out. The partnership is a cash basis, service oriented partnership in which
Cindy is an active partner. The partnership’s assets consist primarily of unrealized receivables and cash. The
partnership also has substantial going concern value (goodwill) which is probably its most valuable asset. The
other partners in the partnership are also active in the business and are not related to Cindy.
Discuss from Cindy’s viewpoint how you would structure the liquidation of her interest under § 736. Answer as
if you are her advocate. Do you think the other partners will agree with this structure? If not, what structure
would they prefer?
107. George (a calendar year taxpayer) owns a 40% interest in the cash-basis GLO LLP. GLO has a natural
business year ending March 31. George has found another opportunity and would like to sell his interest on July
1 of the current tax year to new partner Monica. What are some of the issues that should be considered by
George, Monica, and GLO?
108. Julie is an active owner of a 52% interest in the JIR LLP, a consulting company (service provider). Her
basis in the partnership interest is $100,000, and her share of the partnership’s inside basis in assets is $120,000.
Julie can sell her interest in the LLP on the first day of the tax year to Irene and Rachel (the other partners) for
$100,000 each ($200,000 total). Alternatively, the LLP can distribute $200,000 of cash to redeem Julie’s
interest.
Assume the following: $10,000 of the redemption payment would be for the LLP’s goodwill (which is not
provided for in the partnership agreement); Julie’s share of JIR’s unrealized receivables is $40,000; and JIR has
a § 754 election in effect. What are the advantages and disadvantages of the sale versus the redemption from
Julie’s and JIR’s perspective? What is your recommendation? Explain.
109. Your client has operated a sole proprietorship for several years, and is now interested in raising capital for
expansion. He is considering forming either a C corporation or an LLC.
a.
Describe the treatment of an LLC and discuss any advantages the LLC offers over the C corporation.
b.
Assume instead the client has previously operated as a C corporation. Describe the tax consequences of converting to an LLC.
CHAPTER 11--PARTNERSHIPS: DISTRIBUTIONS,
TRANSFER OF INTERESTS, AND TERMINATIONS Key
1. A cash distribution from a partnership to a partner is generally taxable to the partner.
FALSE
2. For Federal income tax purposes, a distribution from a partnership to a partner is treated the same as a
distribution from a C corporation to its shareholders.
FALSE
3. In a liquidating distribution, a partnership must distribute all of its property to all of its partners.
FALSE
4. A distribution can be “proportionate” (as defined for purposes of Subchapter K) even if only one partner
receives assets from the partnership.
TRUE
5. Loss will be recognized on any distribution from a partnership in which cash, unrealized receivables and/or
appreciated inventory are the only items distributed.
FALSE
6. Generally, no gain is recognized on a proportionate current or liquidating distribution of property even if the
fair market value of property distributed exceeds the partner’s basis in the partnership interest.
TRUE
7. In a proportionate nonliquidating distribution of cash and a capital asset, the partner recognizes gain to the
extent the amount of cash plus the fair market value of property distributed exceeds the partner’s basis in the
partnership interest.
FALSE
8. In a proportionate nonliquidating distribution, cash is deemed to be distributed first, followed by capital and §
1231 assets, and last, unrealized receivables and inventory.
FALSE
9. A gain will only arise on a distribution of cash that exceeds the partner’s basis in the partnership interest. For
this purpose, only cash, checks, and credit card charges are treated as cash.
FALSE
10. The ELF Partnership distributed $20,000 cash to Emma in a proportionate, nonliquidating distribution.
Emma’s basis in her partnership interest was $10,000 immediately before the distribution. As a result of the
distribution, Emma’s basis is reduced to $0 and she recognizes a $10,000 gain.
TRUE
11. Scott owns a 30% interest in the capital and profits of the SOS Partnership. Immediately before he receives
a proportionate nonliquidating distribution from SOS, the basis of his partnership interest is $40,000. The
distribution consists of $30,000 in cash and land with a fair market value of $80,000. SOS’s adjusted basis in
the land immediately before the distribution is $50,000. As a result of the distribution, Scott recognizes no gain
or loss and his basis in the land is $10,000.
TRUE
12. Randi owns a 40% interest in the capital and profits of the RAY Partnership. Immediately before she
receives a proportionate nonliquidating distribution from RAY, the basis for her partnership interest is $60,000.
The distribution consists of $45,000 in cash and land with a fair market value of $72,000. RAY’s adjusted basis
in the land immediately before the distribution is $36,000. As a result of the distribution, Randi recognizes a
gain of $21,000.
FALSE
13. Lori, a partner in the JKL partnership, received a proportionate nonliquidating distribution of $10,000 cash,
unrealized receivables with a basis of $0 and a fair market value of $15,000, and land with a basis of $6,000 and
a fair market value of $10,000. Her basis in the partnership interest immediately before the distributions was
$14,000. She will recognize $0 gain on the distribution, and her basis in the receivables and land will be $0 and
$4,000 respectively.
TRUE
14. Matt, a partner in the MB Partnership, receives a proportionate, nonliquidating distribution of property
having a fair market value of $16,000 and a partnership basis of $23,000. Matt’s basis in the partnership is
$10,000 before the distribution. In this situation, Matt will recognize no gain or loss. He will take a $10,000
basis in the property, and his basis in the partnership interest is reduced to zero.
TRUE
15. Tim and Darby are equal partners in the TD Partnership. Partnership income for the year is $60,000. Tim
needs cash in order to pay tax on his share of the partnership income, but Darby wants to leave the cash in the
partnership for expansion. If the partners agree, it is acceptable for TD to distribute $8,000 to Tim, and no cash
or other property to Darby.
TRUE
16. Marcie is a 40% member of the M&A LLC. Her basis is $10,000 immediately before the LLC distributes to
her $30,000 of cash and land (basis to the LLC of $20,000 and fair market value of $25,000). As a result of the
proportionate, nonliquidating distribution, Marcie recognizes a gain of $20,000 and her basis in the land is $0.
TRUE
17. The BAM Partnership distributed the following assets to partner Barbie in a proportionate non-liquidating
distribution: $10,000 cash, land parcel A (basis of $5,000, fair market value of $30,000) and land parcel B
(basis of $25,000, fair market value of $30,000). Barbie’s basis in her partnership interest was $40,000
immediately before the distribution. Barbie will allocate a basis of $15,000 each to the two land parcels, and her
basis in her partnership interest will be reduced to $0.
FALSE
18. In a proportionate liquidating distribution, RST Partnership distributes to partner Riley cash of $30,000,
accounts receivable (basis of $0, fair market value of $40,000), and land (basis of $65,000, fair market value of
$50,000). Riley’s basis was $40,000 before the distribution. On the liquidation, Riley recognizes a gain of $0,
and her basis is $10,000 in the land and $0 in the accounts receivable.
TRUE
19. In a proportionate liquidating distribution, WYX Partnership distributes to partner William cash of $40,000,
cash basis accounts receivable (basis of $0, fair market value of $10,000), and land (basis of $30,000, fair
market value of $50,000). William’s basis was $80,000 before the distribution. On the liquidation, William
recognizes a $20,000 gain, and he takes a basis of $10,000 in the accounts receivable, and $50,000 in the land.
FALSE
20. Zach’s partnership interest basis is $100,000. Zach receives a proportionate, liquidating distribution from a
liquidating partnership of $50,000 cash and inventory having a basis of $20,000 to the partnership and a fair
market value of $30,000. Zach assigns a basis of $20,000 to the inventory and recognizes a $30,000 loss.
TRUE
21. Carlos receives a proportionate liquidating distribution consisting of $8,000 cash and inventory with a basis
to the partnership of $5,000 and a fair market value of $6,000. His basis in his partnership interest was $15,000
immediately before the distribution. Carlos assigns a basis of $7,000 to the inventory, and recognizes no gain or
loss.
FALSE
22. The JIH Partnership distributed the following assets to partner James in a proportionate liquidating
distribution in which the partnership also liquidated: $25,000 cash, land parcel A (basis of $5,000, fair market
value of $30,000) and land parcel B (basis of $5,000, fair market value of $15,000). James’s basis in his
partnership interest was $85,000 immediately before the distribution. James will allocate bases of $40,000 to
parcel A and $20,000 to parcel B, and he will have no remaining basis in his partnership interest.
TRUE
23. In a proportionate liquidating distribution in which the partnership is also liquidated, Ralph received cash of
$30,000, accounts receivable (basis of $0, fair market value of $20,000), and equipment (basis of $0, fair
market value of $10,000). Immediately before the distribution, Ralph’s basis in the partnership interest was
$40,000. Ralph realizes and recognizes a loss of $10,000, and his basis is $0 in both the accounts receivable and
the equipment.
FALSE
24. Several years ago, the Jaymo Partnership purchased 2,000 shares of ABCO stock (publicly traded) for
$40,000; the stock now has a fair market value of $90,000. If this stock is distributed to Jason in liquidation of
his 30% partnership interest, it is treated as a cash distribution of $75,000 and a property distribution of
$15,000. Assume Jaymo owns no other securities.
TRUE
25. Normally a distribution of property from a partnership does not result in gain recognition. However, a
distribution of marketable securities may be treated, in part, as a distribution of cash that could result in gain
recognition.
TRUE
26. Mark contributed property to the MDB Partnership in 2009. At the time of the contribution, the basis in the
property was $40,000 and its value was $50,000. In 2013, MDB distributed that property to partner Dara.
Because this is a distribution of precontribution gain property, MBD (the partnership) may be required to
recognize a gain that is allocated to all of the partners.
FALSE
27. Generally, a distribution of property does not result in gain to a partner on either a current or liquidating
distribution. A situation where a gain may arise, however, is when a partner contributed appreciated property to
the partnership and that property is distributed back to the contributing partner within seven years of the
contribution.
FALSE
28. A disproportionate distribution arises when the partnership distributes a share of partnership hot assets to
one or more partners that is not the same as the partner’s ownership interest in the partnership.
TRUE
29. A payment to a retiring general partner for his or her share of goodwill of a partnership in which capital is
not a material income-producing factor is classified as a § 736(a) income payment and results in ordinary
income to the retiring partner and a current deduction to the partnership, as long as the goodwill payment is
provided for in the partnership agreement.
FALSE
30. The Crimson Partnership is a service provider. Its assets consist of unrealized receivables (basis of $0, fair
market value of $400,000), cash of $300,000, and land (basis of $200,000, fair market value of $300,000).
Assume 20% general partner Jana has a basis in her partnership interest of $100,000. If the ongoing partnership
distributes $200,000 of cash to Jana in liquidation of her interest in the partnership, she will recognize ordinary
income of $80,000 and a capital gain of $20,000.
TRUE
31. Taylor’s basis in his partnership interest is $140,000, including his $60,000 share of partnership debt. Sandy
buys Taylor’s partnership interest for $100,000 cash and she assumes Taylor’s $60,000 share of the
partnership’s debt. If the partnership owns no hot assets, Taylor will recognize a capital loss of $40,000.
FALSE
32. Beth sells her 25% partnership interest to Katie for $50,000 cash on July 1 of the current tax year. Katie also
assumed Beth’s share of the partnership’s liabilities. Beth’s basis in her partnership interest at the beginning of
the year was $40,000, including a $15,000 share of partnership liabilities. The partnership’s income for the
entire year was $100,000, and Beth’s share of partnership debt was $10,000 as of the date she sold the
partnership interest. Assume the partnership has no hot assets and that its income is earned evenly throughout
the year. Beth recognizes a gain of $12,500 on the sale.
TRUE
33. Nick sells his 25% interest in the LMNO Partnership to new partner Katrina for $57,500. The partnership’s
assets consist of cash ($100,000), land (basis of $90,000, fair market value of $70,000), and inventory (basis of
$40,000, fair market value of $60,000). Nick’s basis in his partnership interest was $57,500. On the sale, Nick
will recognize ordinary income of $5,000 and a capital loss of $5,000.
TRUE
34. A partnership has accounts receivable with a basis of $0 and a fair market value of $30,000 and depreciation
recapture potential of $20,000. All other assets of the partnership are either cash, capital assets, or § 1231 assets.
If a purchaser acquires a 40% interest in the partnership from another partner, the selling partner will be
required to recognize ordinary income of $12,000.
FALSE
35. If a partnership incorporates, it is always deemed to first distribute all of its assets and liabilities to the
partners in complete liquidation. Then the partners are deemed to contribute those assets to the new corporation
(with the corporation assuming the related liabilities) in a transaction that qualifies under § 351.
FALSE
36. In the year a donor gives a partnership interest to a donee, their share of the partnership’s income is prorated
between the donor and donee.
TRUE
37. A partnership is required to make a downward adjustment to the basis of its assets if a partnership interest is
sold and if the total decline in value of partnership assets is more than $250,000, even if a § 754 election is not
in effect.
TRUE
38. A § 754 election is made for a tax year in which the partner recognizes gain or loss on a distribution from
the partnership or the distributee partner’s basis in distributed property is increased or decreased from the inside
basis the partnership held in those assets. The election is made by the partnership each year in which it is
necessary to adjust a partner’s share of the inside basis of partnership assets. In a year in which an unfavorable
result would arise, the partnership can forego making the election.
FALSE
39. Jeremy sold his 40% interest in the HIJ Partnership to Ashley for $400,000. The inside basis of all
partnership assets was $600,000 at the time of the sale. If the partnership makes a § 754 election, it will record a
$160,000 step-up in the basis of the partnership assets, and the step-up will be attributed solely to Ashley.
TRUE
40. The MBA Partnership makes a § 736(b) cash payment of $20,000 to partner Amanda in liquidation of her
interest in the partnership. The partnership owns no hot assets. Amanda’s basis in her partnership interest before
the distribution was $50,000. If the partnership has a § 754 election in effect, it will record a $30,000 decrease
in its inside basis in partnership assets, affecting all the remaining partners in the partnership.
TRUE
41. Bob received a proportionate nonliquidating distribution of land from the BZ Partnership. The land had a
fair market value of $15,000 and a basis to the partnership of $10,000. The land was held for investment
purposes by the partnership. Bob’s basis in his partnership interest immediately before the distribution was
$6,000. If the partnership has a § 754 election in effect, it will record a $4,000 step-down in the basis of
remaining assets, and the step-down will be attributed to all partners in the partnership.
FALSE
42. A partnership continues in existence unless one of the following happens: 1) all assets are distributed to the
partners in liquidation of the partnership, or 2) a majority of the partners vote to adopt a plan of liquidation of
the partnership.
FALSE
43. Rex and Scott operate a law practice in partnership form. Because Rex and Scott are brothers, the
partnership is subject to the family partnership income reallocation rules.
FALSE
44. A limited liability company generally provides limited liability for those owners that are not active in the
management of the LLC but requires owner-managers of the LLC to have unlimited personal liability for LLC
debts.
FALSE
45. Dan receives a proportionate nonliquidating distribution when the basis of his partnership interest is
$30,000. The distribution consists of $10,000 in cash and property with an adjusted basis to the partnership of
$24,000 and a fair market value of $26,500. Dan's basis in the noncash property is:
A. $26,500.
B. $24,000.
C. $20,000.
D. $10,000.
E. None of the above.
46. At the beginning of the year, Elsie’s basis in the E&G Partnership interest is $90,000. She receives a
proportionate nonliquidating distribution from the partnership consisting of $10,000 of cash, unrealized
accounts receivable (basis of $0, fair market value $40,000), and land (basis of $30,000, fair market value of
$50,000). After the distribution, Elsie’s bases in the accounts receivable, land, and partnership interest are:
A. $0; $30,000; and $50,000.
B. $0; $50,000; and $30,000.
C. $40,000; $30,000; and $10,000.
D. $40,000; $40,000; and $0.
E. None of the above.
47. Megan’s basis was $120,000 in the MYP Partnership interest just before she received a proportionate
nonliquidating distribution consisting of land held for investment (basis of $100,000, fair market value of
$130,000) and inventory (basis of $80,000, fair market value of $70,000). After the distribution, Megan’s bases
in the land and inventory are, respectively:
A. $100,000 (land) and $20,000 (inventory).
B. $120,000 (land) and $0 (inventory).
C. $50,000 (land) and $70,000 (inventory).
D. $40,000 (land) and $80,000 (inventory).
E. None of the above.
48. Mark receives a proportionate nonliquidating distribution. At the beginning of the partnership year, the basis
of his partnership interest is $100,000. During the year, he received a cash distribution of $40,000 and a
property distribution (basis of $30,000, fair market value of $25,000). In addition, Mark’s share of partnership
liabilities was reduced by $10,000 during the year. How much gain or loss does Mark recognize; what is his
basis in the property he received; and what is his remaining basis in the partnership interest?
A. $25,000 loss; $25,000 basis in property; $0 remaining basis.
B. $30,000 loss; $30,000 basis in property; $0 remaining basis.
C. $0 gain or loss; $25,000 basis in property; $25,000 remaining basis.
D. $0 gain or loss; $30,000 basis in property; $20,000 remaining basis.
E. $0 gain or loss; $20,000 basis in property; $30,000 remaining basis.
49. Mack has a basis in a partnership interest of $200,000, including his share of partnership debt. At the end
of the current year, the partnership distributed to Mack, in a proportionate nonliquidating distribution, cash of
$20,000, inventory (basis to the partnership of $30,000 and fair market value of $40,000), and land (basis to the
partnership of $40,000 and fair market value of $42,000). In addition, Mack’s share of partnership debt
decreased by $12,000 during the year. What basis does Mack take in the inventory and land and in the
partnership interest (including debt share) following the distribution?
A. $30,000 basis in inventory; $40,000 basis in land, $98,000 basis in partnership.
B. $30,000 basis in inventory; $42,000 basis in land, $110,000 basis in partnership.
C. $40,000 basis in inventory; $40,000 basis in land, $86,000 basis in partnership.
D. $40,000 basis in inventory; $42,000 basis in land, $98,000 basis in partnership.
E. $40,000 basis in inventory; $42,000 basis in land, $110,000 basis in partnership.
50. Frank receives a proportionate nonliquidating distribution from the AEF Partnership. The distribution
consists of $10,000 cash and property (adjusted basis to the partnership of $54,000 and fair market value of
$60,000). Immediately before the distribution, Frank’s adjusted basis in the partnership interest was $50,000.
His basis in the noncash property received is:
A. $0.
B. $40,000.
C. $54,000.
D. $60,000.
E. None of the above.
51. Alyce owns a 30% interest in a continuing partnership. The partnership distributes a $35,000 year-end cash
payment to Alyce. In a proportionate nonliquidating distribution, the partnership also distributed property (basis
of $20,000, fair market value of $30,000) to Alyce. Immediately before the distributions of cash and property,
Alyce’s basis in the partnership interest was $60,000. As a result of the distribution, Alyce recognizes:
A. No gain or loss.
B. Ordinary loss of $5,000.
C. Capital loss of $5,000.
D. Ordinary gain of $5,000.
E. Capital gain of $5,000.
52. Catherine’s basis was $50,000 in the CAR Partnership just before she received a proportionate
nonliquidating distribution consisting of land held for investment with a basis to CAR of $40,000 (value of
$60,000), and inventory with a basis of $40,000 (value of $40,000). After the distribution, Catherine’s bases in
the land and inventory are:
A. $40,000 (land); $40,000 (inventory).
B. $40,000 (land); $10,000 (inventory).
C. $10,000 (land); $40,000 (inventory).
D. $25,000 (land); $25,000 (inventory).
E. None of these statements is correct.
53. Misha receives a proportionate nonliquidating distribution when the basis of her partnership interest is
$60,000. The distribution consists of $80,000 cash and inventory (adjusted basis to the partnership of $10,000,
fair market value of $20,000). How much gain or loss does Misha recognize, and what is her basis in the
distributed inventory and in her partnership interest following the distribution?
A. $0 gain or loss; $10,000 basis in inventory; $0 basis in partnership interest.
B. $0 gain or loss; $20,000 basis in inventory; $50,000 basis in partnership interest.
C. $20,000 capital gain; $0 basis in inventory; $0 basis in partnership interest.
D. $20,000 capital gain; $10,000 basis in inventory; $0 basis in partnership interest.
E. $20,000 ordinary income; $0 basis in inventory; $20,000 basis in partnership interest.
54. Nicky’s basis in her partnership interest was $150,000, including her $40,000 share of partnership liabilities.
The partnership decides to liquidate, and after repaying all liabilities, distributes all remaining assets
proportionately to the partners. Nicky receives $30,000 cash and accounts receivable with a $50,000 basis and a
$48,000 fair market value to the partnership. What gain or loss does Nicky recognize, and what is her basis in
the accounts receivable?
A. $70,000 loss; $50,000 basis.
B. $30,000 loss; $50,000 basis.
C. $32,000 loss; $48,000 basis.
D. $72,000 loss; $48,000 basis.
E. $0 loss; $80,000 basis.
55. Anthony’s basis in the WAM Partnership interest was $200,000 just before he received a proportionate
liquidating distribution consisting of investment land (basis of $90,000, fair market value of $100,000), and
inventory (basis of $30,000, fair market value of $70,000). After the distribution, Anthony’s recognized gain or
loss and his basis in the land and inventory are:
A. $80,000 loss; $90,000 (land); $30,000 (inventory).
B. $70,000 loss; $100,000 (land); $30,000 (inventory).
C. $30,000 loss; $100,000 (land); $70,000 (inventory).
D. $0 gain or loss; $170,000 (land); $30,000 (inventory).
E. None of the above.
56. Beth has an outside basis of $100,000 in the BTDE Partnership as of December 31 of the current year. On
that date the partnership liquidates and distributes to Beth a proportionate distribution of $50,000 cash and
inventory with an inside basis to the partnership of $10,000 and a fair market value of $16,000. In addition,
Beth receives an antique desk (not inventory) which has an inside basis and fair market value of $0 and $5,000,
respectively. None of the distribution is for partnership goodwill. How much gain or loss will Beth recognize on
the distribution, and what basis will she take in the desk?
A. $40,000 loss; $0 basis.
B. $35,000 loss; $5,000 basis.
C. $0 gain or loss; $5,000 basis.
D. $0 gain or loss; $40,000 basis.
E. None of the above.
57. Landis received $90,000 cash and a capital asset (basis of $50,000, fair market value of $60,000) in a
proportionate liquidating distribution. His basis in his partnership interest was $120,000 prior to the distribution.
How much gain or loss does Landis recognize and what is his basis in the asset received?
A. $0 gain or loss; $30,000 basis.
B. $0 gain or loss; $50,000 basis.
C. $0 gain or loss; $60,000 basis.
D. $20,000 gain; $50,000 basis.
E. $30,000 gain; $60,000 basis.
58. Jonathon owns a one-third interest in a liquidating partnership. Immediately before the liquidation,
Jonathon’s basis in the partnership interest is $60,000. The partnership distributes cash of $32,000 and two
parcels of land (each with a fair market value of $10,000). Parcel A has a basis of $2,000 to the partnership and
Parcel B has a basis of $6,000. Jonathon’s basis in the two parcels of land is:
A. Parcel A, $2,000; Parcel B, $6,000.
B. Parcel A, $7,000; Parcel B, $21,000.
C. Parcel A, $10,000; Parcel B, $10,000.
D. Parcel A, $14,000; Parcel B, $14,000.
E. Parcel A, $15,000; Parcel B, $45,000.
59. Michelle receives a proportionate liquidating distribution when the basis of her partnership interest is
$50,000. The distribution consists of $58,000 cash and noninventory property (adjusted basis to the partnership
of $10,000 and fair market value of $12,000). The partnership has no hot assets. How much gain or loss does
Michelle recognize, and what is her basis in the distributed property?
A. $0 gain or loss; $0 basis in property.
B. $0 gain or loss; $50,000 basis in property.
C. $8,000 ordinary income; $0 basis in property.
D. $8,000 capital gain; $10,000 basis in property.
E. $8,000 capital gain; $0 basis in property.
60. Suzy owns a 30% interest in the JSD LLC. In liquidation of the entity, Suzy receives a proportionate
distribution of $30,000 cash, inventory (basis of $16,000, fair market value of $18,000), and land (basis of
$25,000, fair market value of $30,000). Suzy’s basis in the entity immediately before the distribution was
$80,000. As a result of the distribution, what is Suzy’s basis in the inventory and land, and how much gain or
loss does she recognize?
A. $0 basis in inventory; $25,000 basis in land; $0 gain or loss.
B. $16,000 basis in inventory; $34,000 basis in land; $0 gain or loss.
C. $16,000 basis in inventory; $25,000 basis in land; $9,000 loss.
D. $18,000 basis in inventory; $32,000 basis in land; $0 gain.
E. $25,000 basis in inventory; $25,000 basis in land; $0 gain or loss.
61. In a proportionate liquidating distribution, Sam receives a distribution of $30,000 cash, accounts receivable
(basis of $0, fair market value of $50,000), and land (basis of $20,000, fair market value of $50,000). In
addition, the partnership repays all liabilities, of which Sam’s share was $40,000. Sam’s basis in the entity
immediately before the distribution was $120,000. As a result of the distribution, what is Sam’s basis in the
accounts receivable and land, and how much gain or loss does he recognize?
A. $0 basis in accounts receivable; $50,000 basis in land; $0 gain or loss.
B. $0 basis in accounts receivable; $90,000 basis in land; $0 gain or loss.
C. $50,000 basis in accounts receivable; $40,000 basis in land; $0 gain or loss.
D. $50,000 basis in accounts receivable; $50,000 basis in land; $50,000 gain.
E. $0 basis in accounts receivable; $70,000 basis in land; $30,000 loss.
62. In a proportionate liquidating distribution, Ashleigh receives a distribution of $30,000 cash, accounts
receivable (basis of $0, fair market value of $40,000), and land (basis of $40,000, fair market value of $50,000).
In addition, the partnership repays all liabilities, of which Ashleigh’s share was $70,000. Ashleigh’s basis in the
entity immediately before the distribution was $60,000. As a result of the distribution, what is Ashleigh’s basis
in the accounts receivable and land, and how much gain or loss does she recognize?
A. $0 basis in accounts receivable; $0 basis in land; $40,000 gain.
B. $0 basis in accounts receivable; $30,000 basis in land; $0 gain or loss.
C. $0 basis in accounts receivable; $40,000 basis in land; $0 gain or loss.
D. $40,000 basis in accounts receivable; $20,000 basis in land; $0 gain.
E. $40,000 basis in accounts receivable; $20,000 basis in land; $100,000 gain.
63. In a proportionate liquidating distribution, Sara receives a distribution of $40,000 cash, accounts receivable
(basis of $0, fair market value of $30,000), and inventory (basis of $50,000, fair market value of $60,000).
Sara’s basis in the entity immediately before the distribution was $120,000. As a result of the distribution, what
is Sara’s basis in the accounts receivable and inventory, and how much gain or loss does she recognize?
A. $0 basis in accounts receivable; $50,000 basis in inventory; $30,000 loss.
B. $0 basis in accounts receivable; $80,000 basis in inventory; $0 gain or loss.
C. $40,000 basis in accounts receivable; $40,000 basis in inventory; $0 gain or loss.
D. $30,000 basis in accounts receivable; $50,000 basis in inventory; $30,000 loss.
E. $30,000 basis in accounts receivable; $60,000 basis in inventory; $10,000 gain.
64. Which of the following statements correctly reflects the rules regarding proportionate liquidating
distributions?
A. Relief of liabilities is treated as a distribution of cash but only to the extent that the cash distribution does not
exceed the partner’s basis in the partnership interest.
B. A partner’s basis in distributed unrealized receivables is the lesser of the partnership’s basis in the
receivables or their fair market value.
C. The basis of unrealized receivables cannot be stepped up to their fair market value unless the partner has
adequate unabsorbed basis.
D. Assets are deemed distributed in the following order: cash, unrealized receivables and inventory and finally,
capital assets.
E. The partner can recognize gain, but not loss, on a proportionate liquidating distribution.
65. Which of the following distributions would never result in gain recognition to the recipient partner?
A. A distribution of cash that follows a contribution of appreciated property to the partnership.
B. A distribution of a slightly appreciated marketable security.
C. A distribution of property to a partner who, three years ago, contributed other property with a built-in gain.
D. A distribution to a second partner of property contributed by the first partner two years ago.
E. A proportionate distribution of inventory property.
66. Last year, Darby contributed land (basis of $60,000, fair market value of $80,000) to the Seagull LLC in
exchange for a 25% interest in the LLC. In the current year, the LLC distributes the land (now worth $82,000)
to Shelby, who is also a 25% owner. Immediately prior to the distribution, Darby’s basis in the LLC was
$70,000, while Shelby’s basis in the LLC was $110,000. How much gain or loss must be recognized and by
whom? What is Shelby’s basis in the property she receives and Darby’s basis in her partnership interest
following the distribution?
A. No gain or loss; Shelby’s basis in the property is $80,000; Darby’s basis in interest is $70,000.
B. $20,000 gain recognized by Darby; Shelby’s basis in the property is $80,000; Darby’s basis in interest is
$90,000.
C. $22,000 gain recognized by Darby; Shelby’s basis in the property is $82,000; Darby’s basis in interest is
$92,000.
D. $20,000 gain recognized by Shelby; Shelby’s basis in the property is $80,000; Darby’s basis in interest is
$90,000.
E. $22,000 gain recognized by Shelby; Shelby’s basis in the property is $82,000; Darby’s basis in interest is
$92,000.
67. Last year, Miguel contributed nondepreciable property with a basis of $50,000 and a fair market value of
$75,000 to the Starling Partnership in exchange for a 25% interest in the partnership. In the current year, he
receives a nonliquidating distribution from the partnership of other property with a basis to the partnership of
$50,000 and a fair market value of $62,000. The basis in his partnership interest at the time of the distribution
was $60,000. How much gain or loss does Miguel recognize on the distribution? (Assume no other distributions
have been made to Miguel, the property he originally contributed is still owned by the partnership, and this is
not a disguised sale transaction.)
A. $0 gain or loss.
B. $2,000 loss.
C. $2,000 gain.
D. $8,000 gain.
E. $10,000 gain.
68. Which of the following is not typically considered to be a “hot asset?”
A. Accounts receivable of a cash basis partnership.
B. Inventory with a basis of $16,000 and a fair market value of $15,000.
C. Depreciation recapture potential.
D. Land held for development.
E. All of the above are typically considered to be “hot assets.”
69. Tom, Tina, Tatum, and Terry are equal owners in the 4-Ts LLC, a cash basis service entity. 4-Ts has
unrealized receivables of $400,000 (basis of $0), and no other hot assets. A goodwill payment of $50,000 per
partner is provided for in the LLC’s operating agreement. If 4-Ts distributes cash of $300,000 to Tom in
liquidation of his LLC interest, which of the following statements is correct?
A. This is a proportionate distribution with respect to hot assets.
B. The $50,000 payment that relates to LLC goodwill cannot be deducted by the LLC.
C. The partnership will terminate.
D. The $150,000 § 736(a) payment will result in a capital gain to Tom.
E. The $200,000 § 736(b) payment will be taxed to Tom as ordinary income.
70. The December 31, 2013, balance sheet of the RST General Partnership reads as follows.
Cash
Receivables
Capital and § 1231 assets
Total
Adjusted
Basis
$ 65,000
–0–
55,000
$120,000
FMV
$ 65,000
7,500
100,000
$172,500
Roy, capital
Sue, capital
Ted, capital
Total
$ 40,000
40,000
40,000
$120,000
$ 57,500
57,500
57,500
$172,500
The partners share equally in partnership capital, income, gain, loss, deduction and credit. Ted’s adjusted basis for his partnership interest is $40,000.
On December 31, 2013, he retires from the partnership, receiving a $60,000 cash payment in liquidation of his interest. The partnership agreement
states that $2,500 of the payment is for goodwill. Which of the following statements about this distribution is false?
A. If capital is NOT a material income-producing factor to the partnership, the § 736(a) payment will be $2,500.
B. If capital IS a material income-producing factor, the entire $60,000 payment will be a § 736(b) property
payment.
C. The payment for Ted’s share of goodwill will create $2,500 of ordinary income to him.
D. The partnership can deduct any amount that is a § 736(a) payment because it will be determined without
regard to partnership profits.
E. All statements are false.
71. The December 31, 2013, balance sheet of GST Services, LLP reads as follows:
Cash
Receivables
Capital assets
Total
George, capital
Sue, capital
Tom, capital
Total
Adjusted
Basis
$300,000
–0–
120,000
$420,000
$140,000
140,000
140,000
$420,000
FMV
$300,000
150,000
150,000
$600,000
$200,000
200,000
200,000
$600,000
The partners share equally in partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the
partnership, and all partners are active in the business. On December 31, 2013, general partner Sue receives a distribution of $200,000 cash in
liquidation of her partnership interest under § 736. Sue’s outside basis for the partnership interest immediately before the distribution is $150,000.
(Her basis does not correspond to her capital account because she purchased the interest a few years ago at a $10,000 premium.) How much is Sue’s
gain or loss on the distribution and what is its character?
A. $50,000 ordinary income.
B. $40,000 ordinary income; $10,000 capital gain.
C. $40,000 capital gain; $10,000 ordinary income.
D. $50,000 capital gain.
E. None of the above.
72. Which of the following statements is true regarding the sale of a partnership interest?
A. The selling partner’s share of partnership liabilities is disregarded in determining the proceeds from the sale
of a partnership interest.
B. For purposes of computing the selling partner’s gain or loss, the partner’s basis in the partnership interest is
determined as of the last day of the partnership tax year ending before the year in which the interest is sold.
C. If a partner sells an interest in a partnership, income related to that interest for the year of the sale is allocated
to the purchaser.
D. The selling partner could be required to report both ordinary income and a capital loss on sale of the
partnership interest.
E. The partner’s share of partnership “hot assets” is disregarded in determining the character of the partner’s
gain on the sale of the partnership interest.
73. Nicholas is a 25% owner in the DDBN LLC (a calendar year entity). At the end of the last tax year,
Nicholas’s basis in his interest was $50,000, including his $20,000 share of LLC liabilities. On July 1 of the
current tax year, Nicholas sells his LLC interest to Anna for $80,000 cash. In addition, Anna assumes
Nicholas’s share of LLC liabilities, which, at that date, was $15,000. During the current tax year, DDBN’s
taxable income is $120,000 (earned evenly during the year). Nicholas’s share of the LLC’s unrealized
receivables is valued at $6,000 ($0 basis). At the sale date, what is Nicholas’s basis in his LLC interest, how
much gain or loss must he recognize, and what is the character of the gain or loss?
A. $45,000 basis; $6,000 ordinary income; $44,000 capital gain.
B. $60,000 basis; $6,000 ordinary income; $29,000 capital gain.
C. $60,000 basis; $35,000 capital gain.
D. $75,000 basis; $0 ordinary income; $20,000 capital gain.
E. $75,000 basis; $6,000 ordinary income; $14,000 capital gain.
74. The BLM LLC’s balance sheet on August 31 of the current year is as follows.
Cash
Receivables
Capital assets
Nonrecourse debt
Barney, capital
Lillie, capital
Marshall, capital
Adjusted
Basis
$ 60,000
–0–
90,000
$150,000
FMV
$ 60,000
150,000
300,000
$510,000
$ 90,000
20,000
20,000
20,000
$150,000
$ 90,000
140,000
140,000
140,000
$510,000
The nonrecourse debt is shared equally among the LLC members. On that date, Lillie sells her one-third interest to Robyn for $170,000, including
cash and relief of Lillie’s share of the nonrecourse debt. Lillie’s outside basis for her interest in the LLC is $50,000, including her share of the LLC’s
debt. How much capital gain and/or ordinary income will Lillie recognize on the sale?
A. $100,000 capital gain; $50,000 ordinary income.
B. $120,000 capital gain; $0 ordinary income.
C. $150,000 capital gain; $0 ordinary income.
D. $70,000 capital gain; $50,000 ordinary income.
E. None of the above.
75. Which of the following statements about the transfer of a partnership interest is not true?
A. The seller’s adjusted basis for the partnership interest is increased by the seller’s share of undistributed
partnership income (or reduced by partnership loss) for the portion of the partnership’s taxable year ending on
the date of the sale.
B. The partnership taxable year generally does not close with respect to a partner who transfers a partnership
interest at death; all amounts are allocated to the successor.
C. The amount realized on the sale of a partnership interest is the sum of any money and the fair market value
of any property received for the interest, plus the selling partner’s share of partnership liabilities under § 752.
D. With respect to a transfer of a partnership interest by gift, all partnership gain, loss, credit, etc., items are
allocated between the donor and the donee.
E. All of the above are true statements.
76. Brittany, Jennifer, and Daniel are equal partners in the BJD Partnership. The partnership balance sheet reads
as follows on December 31 of the current year.
Cash
Unrealized receivables
Land
Total
Adjusted
Basis
$ 75,000
–0–
45,000
$120,000
FMV
$ 75,000
51,000
63,000
$189,000
Brittany, capital
Jennifer, capital
Daniel, capital
Total
$ 40,000
40,000
40,000
$120,000
$ 63,000
63,000
63,000
$189,000
Partner Daniel has an adjusted basis of $40,000 for his partnership interest. If Daniel sells his entire partnership interest to new partner Amber for
$73,000 cash, how much can the partnership step-up the basis of Amber’s share of partnership assets under §§ 754 and 743(b)?
A. $6,000.
B. $17,000.
C. $23,000.
D. $33,000.
E. None of the above.
77. Partner Jordan received a distribution of $90,000 cash from the JKL Partnership in complete liquidation of
his partnership interest. If Jordan’s outside basis immediately before the distribution was $80,000, and if the
partnership has made (and not revoked) a § 754 election in a prior year, which of the following statements is
true? (Assume the partnership owns no “hot assets.”)
A. The partnership will step-down the basis of its assets by $10,000.
B. The partnership will step-up the basis of its assets by $10,000.
C. Jordan will recognize a $10,000 capital gain on the distribution.
D. Both a. and c. are true.
E. Both b. and c. are true.
78. The RST Partnership makes a proportionate distribution of its assets to Ryan, in complete liquidation of his
partnership interest. The distribution consists of $40,000 in cash and capital assets with a basis to the
partnership of $30,000 and a fair market value of $48,000. None of the payment is for partnership goodwill. At
the time of the distribution, Ryan’s partnership basis is $45,000 and the partnership has no liabilities and no
“hot assets.” If the partnership makes an optional basis adjustment election on a timely filed return, it
recognizes:
A. Capital gain of $25,000 and increases the basis of its remaining assets by $12,500.
B. Capital loss of $5,000 and decreases the basis of its remaining assets by $5,000.
C. No gain or loss and increases the basis of its remaining assets by $25,000.
D. No gain or loss and decreases the basis of its remaining assets by $58,000.
E. None of the above.
79. Cynthia sells her 1/3 interest in the CAR Partnership to Brandon for $95,000 cash. On the date of sale, the
partnership balance sheet and agreed-upon fair market values were as follows:
Cash
Receivables
Land
Total
Adjusted
Basis
$40,000
–0–
50,000
$90,000
FMV
$ 40,000
60,000
125,000
$225,000
Cynthia, capital
Arnold, capital
Ralph, capital
Total
$30,000
30,000
30,000
$90,000
$ 75,000
75,000
75,000
$225,000
If the partnership has a § 754 election in effect, the total “step-up” in basis of partnership assets that will be allocated to Brandon is:
A. $75,000.
B. $65,000.
C. $45,000.
D. $20,000.
E. $0.
80. A partnership may make an optional election to adjust the basis of its property on a distribution to a partner
which liquidates the partner’s entire interest in the partnership. If such an election is in effect, the partnership:
A. Generally applies the election to transfers that take place at any later date, unless the election is revoked.
B. Only adjusts the basis of its property for differences in basis between that of the partnership and a distributee
partner if a transferor-transferee situation arises within two years after the distribution.
C. Increases the basis of similar retained assets when a distributee partner takes a basis which is greater than the
partnership’s basis in these assets, assuming the partnership does not have any receivables or inventory.
D. Decreases the basis of similar retained assets when the distributee partner recognizes gain on the distribution.
E. All of the above.
81. Which of the following transactions will not result in termination of a partnership for Federal tax purposes?
A. The partnership is incorporated.
B. A 70% interest in partnership capital and profits is sold to a third party purchaser.
C. Cash is distributed in liquidation of a 60% partner’s interest in a five-partner partnership.
D. A 40% interest in partnership capital and profits is sold to the other partner in a two-partner partnership.
E. None of the above.
82. On December 31 of last year, Maria gave her daughter, Chelsea, a gift of a 25% interest in a partnership in
which capital is a material income-producing factor. For the current calendar year, the partnership’s ordinary
income was $100,000. Maria and Chelsea were the only partners, and there were no guaranteed payments.
Maria’s services performed for the partnership were worth $60,000, and Chelsea has never performed any
services. What is Maria’s distributive share of partnership income for the current year?
A. $60,000.
B. $75,000.
C. $90,000.
D. $100,000.
E. None of the above.
83. Which of the following statements, if any, about an LLC is false?
A. An LLC is usually taxed like a partnership.
B. “Members” of an LLC generally have limited personal liability for debts of the LLC, except for the
managing member who has unlimited liability for LLC debts.
C. “Members” of an LLC can participate in management of the LLC unless the member agrees not to
participate.
D. An LLC can specially allocate income items, as long as the substantial economic effect rules of § 704(b) are
followed.
E. None of the above statements is false.
84. George is planning to retire from the GDP LLC, where he is an active managing member owning a 60%
interest. Capital is not a material income-producing factor to GDP. The LLC can either redeem his interest
under § 736 or he can sell his interest to Dale, who currently owns a 20% interest. The LLC’s operating
agreement is silent regarding treatment of goodwill. As to George’s alternatives, which one of the following
statements is true?
A. Either the sale or the redemption would terminate the partnership.
B. Payments to George for his share of GDP’s goodwill would be treated the same for either a sale or
redemption.
C. George will report ordinary income related to his share of “hot assets” under either the sale or the redemption
scenario.
D. If GDP/Dale negotiate payments over several years, either an installment sale or a redemption over time
would result in the same tax situation to George.
E. All of the above statements are true.
85. Match the following statements with the best match from the choices below. Note: Choice L may be used
more than once.
1. Unrealized receivable
2. Liquidating
distribution
3. Nonqualified
distribution
4. Substantially appreciated
inventory
5. Inventory
6. Nonliquidating
distribution
7. Depreciation recapture
8. Disproportionate
distribution
9. Hot assets
10. Ordering rules
11. Optional adjustment
election
No correct match provided. 3
Cash, then inventory and unrealized
receivables, then other assets. 10
Ordinary income-producing items.
9
Fair market value exceeds 120% of basis.
Does not eliminate the partner’s interest in the
partnership.
Sometimes treated as an unrealized
receivable.
Any partnership assets other than cash, capital,
or § 1231 assets.
4
Cash basis accounts receivable, for example.
Changes the partner’s or the partnership’s
ordinary income potential.
Terminates the partner’s interest in the
partnership.
Inside basis of partnership property can be
adjusted to reflect the purchase price paid.
1
6
7
5
8
2
11
86. Connie owns a one-third capital and profits interest in the calendar-year CDB Partnership. Her adjusted
basis for her partnership interest was $120,000 when she received a proportionate nonliquidating distribution of
the following assets:
Cash
Land held for investment
Partnership’s Basis in Asset
$140,000
30,000
Asset’s Fair Market Value
$140,000
60,000
a.
Calculate Connie’s recognized gain or loss on the distribution, if any.
b.
Calculate Connie’s basis in the land received.
c.
Calculate Connie’s basis for her partnership interest after the distribution.
a.
Connie recognizes a gain of $20,000 on the distribution, which is the amount by which the $140,000 cash distribution exceeds her
$120,000 outside basis.
b.
The cash distribution reduces Connie’s basis to $0. When the land is distributed, it takes the lesser of a carryover basis of $30,000 or
Connie’s remaining basis of $0.
c.
As Connie has no remaining basis for her partnership interest after the cash distribution, her outside basis is $0.
87. Randy owns a one-fourth capital and profits interest in the calendar-year RUSR Partnership. His adjusted
basis for his partnership interest was $200,000 when he received a proportionate nonliquidating distribution of
the following assets:
Cash
Inventory
Partnership’s Basis in Asset
$120,000
60,000
Asset’s Fair Market Value
$120,000
90,000
a.
Calculate Randy’s recognized gain or loss on the distribution, if any. Explain.
b.
Calculate Randy’s basis in the inventory received.
c.
Calculate Randy’s basis for his partnership interest after the distribution.
a.
Randy recognizes no gain or loss. As the cash received does not exceed his basis in the partnership interest, no gain is recognized. Because
this is a nonliquidating distribution, no loss is recognized.
b.
Randy’s basis in the inventory is $60,000. The cash distribution reduces Randy’s basis to $80,000. When the inventory is distributed, it
takes the lesser of a carryover basis of $60,000 or Randy’s remaining basis.
c.
The inventory distribution reduces Randy’s basis from $80,000 (after the cash distribution) to $20,000.
88. Karli owns a 25% capital and profits interest in the calendar-year KJDV Partnership. Her adjusted basis for
her partnership interest on July 1 of the current year is $200,000. On that date, she receives a proportionate
nonliquidating distribution of the following assets:
Cash
Inventory
Land (held for investment)
Partnership’s Basis in Asset
$120,000
50,000
70,000
a.
Calculate Karli’s recognized gain or loss on the distribution, if any.
b.
Calculate Karli’s basis in the inventory received.
c.
Calculate Karli’s basis in land received. The land is a capital asset.
d.
Calculate Karli’s basis for her partnership interest after the distribution.
Asset’s Fair Market Value
$120,000
60,000
100,000
a.
Karli will not recognize any gain or loss on the distribution because the $120,000 cash distributed does not exceed
her $200,000 outside basis.
b.
The inventory has an adjusted basis of $50,000 to Karli. The partnership will distribute the $120,000 cash first,
thereby reducing her outside basis for her partnership interest to $80,000 ($200,000 – $120,000). The inventory
will be distributed next, taking a carryover basis of $50,000 and reducing the adjusted basis for her partnership
interest to $30,000.
c.
The land parcel is distributed last and takes a $30,000 substituted basis because the basis in the land cannot exceed
Karli’s remaining basis in her partnership interest.
d.
Karli’s basis for her partnership interest after the distribution is $0. Her entire $200,000 outside basis has been
allocated to the distributed assets in the following amounts:
Cash
Inventory
Land
$120,000
50,000
30,000
89. Melissa is a partner in a continuing partnership. At the end of the current year, the partnership makes a
proportionate, nonliquidating distribution to Melissa of $50,000 cash, inventory (basis of $22,000, fair market
value of $20,000), and land (basis of $30,000, fair market value of $60,000). Melissa’s basis in the partnership
interest was $90,000 before the distribution. What is Melissa’s basis in the inventory, land, and partnership
interest following the distribution?
Beginning basis in Melissa’s interest
Less: Cash distribution
Basis before property distributions
Less: Inventory distribution
Less: Land distribution
Basis after property distributions
$90,000
(50,000)
$40,000
(22,000)
(18,000)
–0–
Melissa’s basis in the inventory equals the partnership’s basis in the inventory. Whether the property is appreciated or depreciated does not matter.
Her basis in the land is a substituted basis equal to the basis in the partnership interest following the inventory and cash distributions.
90. In a proportionate nonliquidating distribution of his 30% interest in the MNO LLC, Neil received cash
($60,000), land (basis of $40,000 and value of $75,000), and unrealized receivables (basis of $0 and value of
$22,000). In addition, Neil is relieved of his $40,000 share of the LLC’s liabilities. Neil’s basis in MNO
(including his share of LLC liabilities) was $80,000 immediately prior to this distribution.
a.
How much gain or loss does Neil recognize on this distribution?
b.
What is Neil’s basis in the receivables and land he receives in the distribution?
c.
What is Neil’s basis in the LLC interest following the distribution?
a.
Neil recognizes a gain of $20,000. He received a cash distribution of $100,000 (including his relief of liabilities), against his basis of
$80,000.
b.
Neil has a carryover/substituted basis in the unrealized receivables of $0. He also has a $0 basis in the land.
c.
Neil’s basis in the LLC interest is $0 following the distribution.
91. In a proportionate liquidating distribution of his 40% interest in the RST LLC, Stuart received cash
($100,000), land (basis of $60,000 and value of $90,000), and unrealized receivables (basis of $0 and value of
$40,000). In addition, Stuart is relieved of his $80,000 share of the LLC’s liabilities. Stuart’s basis in RST
(including his share of LLC liabilities) was $200,000 immediately prior to this distribution.
a.
How much gain or loss does Stuart recognize on this distribution?
b.
What is Stuart’s basis in the receivables and land he receives in the distribution?
a.
Stuart recognizes no gain or loss. He received a cash distribution of $180,000 (including his relief of liabilities), which did not exceed his
basis of $200,000. Even though this is a liquidating distribution, Stuart received property other than cash, unrealized receivables and
inventory so he may not claim a loss.
b.
Stuart’s basis is reduced to $20,000 by the cash distribution. He has a carryover/substituted basis in the unrealized receivables of $0. The
land absorbs the remaining $20,000 basis.
92. In a proportionate liquidating distribution in which the partnership is liquidated, Marcus received cash of
$60,000, inventory (basis of $10,000, fair market value of $12,000), and a capital asset (basis and fair market
value of $22,000). Immediately before the distribution, Marcus’s basis in the partnership interest was $100,000.
a.
How much gain or loss will Marcus recognize on the distribution?
b.
What is Marcus’s basis in the inventory and the capital asset?
a.
Marcus does not recognize a capital gain or loss on the liquidation of his partnership interest. He did not receive cash in excess of his basis
in the partnership interest, so he does not recognize a gain. Also, because Marcus received assets other than cash and “hot assets,” he may
not recognize a loss.
b.
Marcus’s bases in the inventory and capital asset are $10,000 and $30,000, respectively. His basis is reduced to $40,000 by the cash
distribution. The inventory is distributed next and takes a $10,000 carryover basis. The remaining $30,000 basis is allocated to the capital
asset.
93. In a proportionate liquidating distribution in which the partnership is liquidated, Bill received cash of
$120,000, inventory (basis of $6,000, fair market value of $8,000), and a capital asset (basis and fair market
value of $16,000). Immediately before the distribution, Bill’s basis in the partnership interest was $90,000.
a.
How much gain or loss will Bill recognize on the distribution?
b.
What is Bill’s basis in the inventory and the capital asset?
a.
Bill recognizes a capital gain of $30,000 on the liquidation of his partnership interest. This equals the excess of the cash distribution over
Bill’s basis in his partnership interest before the distribution ($120,000 cash – $90,000 basis).
b.
Bill’s bases in the inventory and capital asset are both $0. His basis is reduced to $0 by the cash distribution, so he has no remaining basis
to allocate to the other properties.
94. Josh has a 25% capital and profits interest in the calendar-year GDJ Partnership. His adjusted basis for his
partnership interest on October 15 of the current year is $300,000. On that date, the partnership liquidates and
makes a proportionate distribution of the following assets to Josh.
Cash
Inventory
Partnership’s Basis in Asset
$ 70,000
120,000
Asset’s Fair Market Value
$ 70,000
150,000
a.
Calculate Josh’s recognized gain or loss on the liquidating distribution, if any.
b.
How would your answer to a. change if the partnership also distributed a small parcel of land it had held for investment to Josh? Assume
the land has a $5,000 adjusted basis (FMV is $8,000) to the partnership.
a.
Josh recognizes a $110,000 capital loss on the distribution. The loss is the difference between his $300,000 adjusted basis and the
$190,000 ($70,000 + $120,000) inside basis of the cash and inventory distributed to him.
b.
Josh would not recognize any loss on the distribution and the land would take a $110,000 adjusted basis. A loss cannot be recognized if
any assets other than cash, unrealized receivables, and inventory are received in the distribution. Because land is generally a capital asset,
it will absorb all of the remaining basis of $110,000.
95. The December 31, 2013, balance sheet of DBW, LLP, a service-providing partnership is as follows:
Cash
Receivables
Capital assets
Total
Adjusted
Basis
$180,000
–0–
90,000
$270,000
FMV
$180,000
60,000
120,000
$360,000
Dana, capital
Brooke, capital
Whitney, capital
Total
$ 90,000
90,000
90,000
$270,000
$120,000
120,000
120,000
$360,000
The partners share equally in partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the
partnership. On December 31, 2013, partner Dana (who is an active managing partner in the partnership) receives a distribution of $120,000 cash in
liquidation of her partnership interest under § 736. Dana’s outside basis for the partnership interest immediately before the distribution is $90,000.
How much is Dana’s gain or loss on the distribution and what is its character?
The payment for Dana’s share of the unrealized receivables is a § 736(a) payment, taxed as ordinary income.
Dana’s share of the receivables is $20,000 ($60,000 ´ 1/3). The § 736(b) payment is $100,000, consisting of the
amount paid for Dana’s 1/3 share of the partnership cash and capital assets. The § 736(b) payment is treated
first as a return of Dana’s $90,000 outside basis. The rest of the § 736(b) payment is taxed to Dana as a $10,000
capital gain.
96. The December 31, 2013, balance sheet of the BCD LLP reads as follows.
Cash
Receivables
Capital assets
Total
Adjusted
Basis
$210,000
–0–
42,000
$252,000
FMV
$210,000
120,000
69,000
$399,000
Ben, capital
Christina, capital
Danielle, capital
Total
$ 84,000
84,000
84,000
$252,000
$133,000
133,000
133,000
$399,000
Each partner shares in 1/3 of the partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the
partnership. On December 31, 2013, general partner Christina receives a distribution of $140,000 cash in liquidation of her partnership interest under
§ 736. Nothing is stated in the partnership agreement about goodwill. Christina’s outside basis for the partnership interest immediately before the
distribution is $84,000.
How much is Christina’s recognized gain from the distribution and what is the character of the gain?
Christina will recognize $47,000 of ordinary income and $9,000 of capital gain. Under § 736(a), the $40,000
($120,000 ´ 1/3) paid for Christina’s share of unrealized receivables will be taxed to her as a $40,000
guaranteed payment. In addition, the $7,000 ($140,000 – $133,000) paid for her share of unstated goodwill will
be treated as a guaranteed payment. The remaining $93,000 ($140,000 – $47,000) cash distribution will be
treated as a § 736(b) payment. The first $84,000 of this payment will be a return of Christina’s outside basis.
The remaining $9,000 will be taxed to her as capital gain.
97. Susan is a one-fourth limited partner in the SJ Partnership in which capital is not a material
income-producing factor. Partnership assets consist of land (fair market value of $100,000, basis of $80,000),
accounts receivable (fair market value of $100,000, basis of $0) and cash of $200,000. SJ distributes $100,000
of the cash to Susan in liquidation of her interest. Susan’s basis in the partnership interest was $70,000
immediately before the distribution. How much gain or loss does Susan recognize and what is its character?
How much can the partnership deduct?
Susan recognizes $25,000 of ordinary income and a $5,000 capital gain; the partnership cannot claim a
deduction. Because Susan is a limited partner, SJ’s $25,000 payment for her share of unrealized receivables is
treated as a § 736(b) payment. As such, Susan recognizes ordinary income, but the partnership cannot claim a
deduction. The remaining $75,000 payment exceeds Susan’s $70,000 basis in the partnership interest by $5,000;
therefore, Susan recognizes a $5,000 capital gain on disposition of the interest.
98. Jeremy is an active partner who owns a 30% interest in the JS LLP (in which capital is not a material
income-producing factor). Partnership assets consist of land (fair market value of $200,000, basis of $140,000),
accounts receivable (fair market value of $200,000, basis of $0), and cash of $400,000. JS distributes $220,000
of the cash to Jeremy in liquidation of his interest. In addition, Jeremy is relieved of his $40,000 share of the
LLP’s liabilities. The total payment includes $20,000 for Jeremy’s share of JS goodwill (for which the
agreement does not provide). Jeremy’s basis in the partnership interest (including his share of the partnership’s
liabilities) is $120,000 immediately before the distribution. How much gain or loss does Jeremy recognize and
what is its character? How much can the partnership deduct?
Jeremy recognizes $80,000 of ordinary income and a $60,000 capital gain. The ordinary income equals
Jeremy’s $60,000 share of accounts receivable ($200,000 ´ 30%) and his $20,000 payment for goodwill. [Total
asset value is $800,000 ($200,000 + $200,000 + $400,000) and Jeremy’s share is $240,000 ($800,000 ´ 30%).
As Jeremy receives $260,000, the $20,000 excess ($260,000 – $240,000) is for unstated goodwill).] The
remaining payment to Jeremy ($260,000 – $80,000 = $180,000) is treated as a § 736(b) payment, which is
offset by Jeremy’s basis of $120,000.
Jeremy is treated as a general partner and a goodwill payment is not provided for in the partnership agreement.
Therefore, JS’s $80,000 payment for Jeremy’s share of receivables and unstated goodwill is a § 736(a) payment
that is deductible by the partnership.
99. Serena owns a 40% interest in the RST LLP. Partnership assets consist of land (fair market value of
$100,000, basis of $80,000), accounts receivable (fair market value of $120,000, basis of $0), and cash of
$180,000. Serena sells her interest in RST to Jaclyn for cash of $140,000. In addition, Jaclyn assumes Serena’s
$40,000 share of the LLP’s liabilities. Serena’s basis in the partnership interest (including her share of the
partnership’s liabilities) is $120,000 immediately before the sale.
a.
How much gain or loss does Serena recognize and what is its character?
b.
What is Jaclyn’s basis in the partnership interest?
c.
If the LLP has a § 754 election in effect, how much is the adjustment and to which partner(s) is it allocated?
a.
Serena recognizes a gain of $60,000, including ordinary income of $48,000 and a capital gain of $12,000. She received $140,000 plus
relief of $40,000 of liabilities for a total of $180,000. Her basis in the LLP interest was $120,000, resulting in a net gain of $60,000. Of this
gain, she reports ordinary income in the amount of her share of the LLP’s unrealized receivables, or $48,000 ($120,000 ´ 40%). The
remaining gain is a capital gain.
b.
Jaclyn’s basis equals the $180,000 paid, including the $40,000 share of the LLP’s liabilities.
b.
If the LLP has a § 754 election in effect, it records an adjustment of $76,000 {$180,000 paid – $104,000 share of inside basis [($80,000 +
$0 + $180,000) ´ 40%]}. This step up is allocated to Jaclyn.
100. On August 31 of the current tax year, the balance sheet of the RBD General Partnership is as follows:
Cash
Receivables
Capital assets
Total
Adjusted
Basis
$150,000
–0–
600,000
$750,000
FMV
$150,000
90,000
660,000
$900,000
Nonrecourse debt
Rachel, capital
Barry, capital
Dale, capital
Total
$150,000
200,000
200,000
200,000
$750,000
$150,000
250,000
250,000
250,000
$900,000
On that date, Rachel sells her one-third partnership interest to Lisa for $300,000, including cash and relief of Rachel’s share of the nonrecourse debt.
The nonrecourse debt is shared equally among the partners. Rachel’s outside basis for her partnership interest is $250,000 (including her share of
partnership debt). How much capital gain and/or ordinary income will Rachel recognize on the sale?
Rachel’s realized gain is $50,000 ($300,000 received less $250,000 outside basis). As the receivables are a
§ 751 “hot asset,” Rachel is treated as having sold her 1/3 share and, therefore, will recognize $30,000 ordinary
income. The rest of the sale is taxed under the general rule of § 741 and generates a capital gain of $20,000.
101. Hannah sells her 25% interest in the HIJK Partnership to Alyssa for $120,000 cash. At the end of the year
prior to the sale, Hannah’s basis in HIJK was $70,000. The partnership allocates $15,000 of income to Hannah
for the portion of the year she was a partner. On the date of the sale, the partnership assets and the agreed fair
market values were as follows.
Cash
Accounts Receivable
Land
Total
Adjusted
Basis
$100,000
–0–
240,000
$340,000
FMV
$100,000
80,000
220,000
$400,000
Determine the amount and character of any gain that Hannah recognizes on the sale.
Hannah’s basis is increased from $70,000 at the beginning of the year to $85,000 at the sale date, as a result of
HIJK’s allocation of $15,000 of income to her during the sale year. Her total gain is $35,000 ($120,000 sales
price – $85,000 basis). Hannah recognizes $20,000 of ordinary income under § 751(a) and a $15,000 capital
gain under § 741.
Hannah recognizes ordinary income to the extent of her share of the partnership’s inventory and unrealized
receivables. Hannah’s 25% share of the receivables is $20,000 (25% ´ $80,000). The difference between the
amount Alyssa paid ($120,000) and Hannah’s share of the value of partnership assets ($100,000) is probably the
value of the partnership’s intangible assets or goodwill.
102. The December 31, 2013, balance sheet of the calendar-year JKL Partnership reads as follows.
Cash
Capital asset (nondepreciable)
Total
Adjusted
Basis
$24,000
33,000
$57,000
FMV
$ 24,000
105,000
$129,000
Jan, capital
Ken, capital
Laura, capital
Total
$19,000
19,000
19,000
$57,000
$ 43,000
43,000
43,000
$129,000
Each partner shares in 1/3 of the partnership capital, income, gain, loss, deduction and credit. On December 31, 2013, Jan sells her 1/3 partnership
interest to Jennifer for $43,000 cash. Assume the partnership makes a § 754 election for 2013.
a.
What is the amount of Jennifer’s “step-up” adjustment under § 743(b)?
b.
If the nondepreciable capital asset is sold the next year for $120,000, determine the amount of gain that Jennifer will recognize on her tax
return because of the sale.
a.
Jennifer has a § 743(b) step-up adjustment of $24,000 under § 754. The adjustment is determined by subtracting Jennifer’s $19,000 share
of the inside basis of partnership assets from her $43,000 purchase price for the interest.
b.
Jennifer recognizes a $5,000 gain on the sale of the nondepreciable capital asset. When Jennifer acquires the partnership interest, the
$24,000 § 743(b) adjustment is allocated to the capital asset under § 755. When the partnership sells the capital asset for $120,000,
Jennifer can offset $24,000 of the $29,000 [($120,000 – $33,000) ´ 1/3] gain she would otherwise recognize with the § 743(b) adjustment.
The remaining $5,000 of gain allocated to Jennifer is taxed to her on her return.
103. Compare the different tax results (gains, losses, basis) that might arise for a partner in a proportionate
nonliquidating distribution vs. a proportionate liquidating distribution. Consider the general rules only.
Gains. For both a proportionate liquidating and a nonliquidating distribution, gain generally arises only upon
distribution of cash in excess of the partner’s basis in the partnership. Cash includes relief of the partner’s share
of partnership liabilities, as well as a portion of certain marketable security distributions.
Losses. In a nonliqidating distribution, a loss deduction is not permitted. Because the partner remains a partner
in the partnership, the ultimate loss is not realized. In a liquidating distribution, a realized loss might be
deductible if the partner receives only cash and ordinary-income producing property (unrealized receivables and
inventory). If other property (capital or § 1231 assets) is distributed, that property absorbs any remaining basis
and the loss is not currently deductible.
Basis. In a nonliquidating distribution, the basis of distributed property is the lesser of the partnership’s basis in
the property or the partner’s remaining basis in the partnership interest. This same result holds for a liquidating
distribution, except that if third tier (capital or § 1231) assets are distributed, those assets absorb any remaining
basis in the partnership interest.
104. Your client, Greg, transferred precontribution gain property to BIG LLC on December 31, 2013, for a 30%
interest.
a.
Describe two types of distributions that might result in some or all of this precontribution gain being recognized by Greg.
b.
In general terms, what is the purpose of these rules?
a.
Distribution of the precontribution gain property to another partner. Any previously unrealized precontribution gain would be
recognized by Greg if BIG distributed the property to another partner before 2021.
Distribution of other property to contributing partner. If BIG distributes a second property to Greg before 2021, Greg might be taxed
on any previously unrecognized built-in gain.
b.
Purpose and effect of rules. These rules are designed to ensure any precontribution gain is taxed to the person who owned the property at
the time the gain arose.
105. a.
When does a disproportionate distribution arise?
b.
When does a disproportionate distribution not arise?
c.
In general terms, what is the effect of a disproportionate distribution?
a.
A disproportionate distribution arises when a partnership distributes property that changes the proportionate ownership interests of the
various partners in the partnership’s “hot assets.” For example, a partnership might distribute inventory to one partner and cash to another.
b.
A disproportionate distribution does not arise if (1) the partnership owns no hot assets, (2) the partnership distributes only non-hot assets
and that distribution is proportionate to the partners’ ownership interests, or (3) the partnership distributes hot- and non-hot assets in
proportion to the partners’ ownership percentages. Note that in the second situation, the distribution of each specific type of non-hot asset
does not have to be proportionate.
c.
A disproportionate distribution is treated first as being a proportionate distribution to the partners. Second, the partnership is treated as
distributing the remaining property in exchange for the property that was deemed distributed in the first step. Normal distribution rules
apply, so the exchange might result in a current gain to either the partner or the partnership, or it might result in one party receiving
property with a reduced basis such that the gain would be deferred.
106. Cindy, a 20% general partner in the CDE Partnership, wants to retire and has approached the other partners
about having the partnership buy her out. The partnership is a cash basis, service oriented partnership in which
Cindy is an active partner. The partnership’s assets consist primarily of unrealized receivables and cash. The
partnership also has substantial going concern value (goodwill) which is probably its most valuable asset. The
other partners in the partnership are also active in the business and are not related to Cindy.
Discuss from Cindy’s viewpoint how you would structure the liquidation of her interest under § 736. Answer as
if you are her advocate. Do you think the other partners will agree with this structure? If not, what structure
would they prefer?
Cindy will prefer to treat the cash received for her share of the partnership goodwill as a § 736(b) payment.
Section 736(b) payments are taxed as a return of basis and capital gain to the recipient partner.
The goodwill can be treated as a § 736(b) payment if the partnership agreement provides for the goodwill.
Unfortunately, the partnership probably will prefer to treat the payment for goodwill as a § 736(a) payment,
because this will allow the partnership to deduct the amounts paid for Cindy’s share of partnership goodwill.
The payment for Cindy’s share of the goodwill will be treated as a § 736(a) payment if the goodwill is not
provided for in the partnership agreement.
Cindy and the partnership can control how the goodwill will be treated. In situations such as this, the
partnership typically has the more powerful position in the negotiations. This typically allows the partnership to
dictate the treatment of goodwill as a § 736(a) payment.
107. George (a calendar year taxpayer) owns a 40% interest in the cash-basis GLO LLP. GLO has a natural
business year ending March 31. George has found another opportunity and would like to sell his interest on July
1 of the current tax year to new partner Monica. What are some of the issues that should be considered by
George, Monica, and GLO?
On sale of a partnership interest, the income share is allocated between the buyer and the seller. The allocation
can be based on an interim closing of the books or a daily proration. As the tax year closes with respect to
George, he would report income from the GLO K-1’s as of March 1 and as of July 1. Although income
bunching occurs, GLO is not required to issue a Schedule K-1 until its normal due date. Thus, George might
have to file an extension for his tax return for the year of the sale.
George recognizes a gain or loss on sale of his partnership interest. Because the partnership uses the cash
method, it probably has substantial unrealized receivables and this results in ordinary income to George. His
remaining gain or loss is from sale of his partnership interest and is capital in nature.
Because of the value inherent in the unrealized receivables, Monica would probably pay a premium over her
share of GLO’s inside basis in its assets. Monica should request that the partnership make a § 754 election (if an
election is not already in effect). The resulting step up in the inside basis of the assets would be allocated to her,
and this reduces her allocable share of income when the receivables are collected.
108. Julie is an active owner of a 52% interest in the JIR LLP, a consulting company (service provider). Her
basis in the partnership interest is $100,000, and her share of the partnership’s inside basis in assets is $120,000.
Julie can sell her interest in the LLP on the first day of the tax year to Irene and Rachel (the other partners) for
$100,000 each ($200,000 total). Alternatively, the LLP can distribute $200,000 of cash to redeem Julie’s
interest.
Assume the following: $10,000 of the redemption payment would be for the LLP’s goodwill (which is not
provided for in the partnership agreement); Julie’s share of JIR’s unrealized receivables is $40,000; and JIR has
a § 754 election in effect. What are the advantages and disadvantages of the sale versus the redemption from
Julie’s and JIR’s perspective? What is your recommendation? Explain.
Sale. On a sale of the partnership interest for $200,000, Julie recognizes a gain of $100,000, which is classified
as $40,000 of ordinary income and a $60,000 capital gain. The partnership reflects a step up allocated to Irene
and Rachel of $80,000 ($200,000 purchase price less $120,000 share of JIR’s inside basis). The goodwill
portion of the payment does not affect Julie’s treatment of the sales price. The partnership is not involved in the
transaction so no portion of the payment is deductible by it. Because this is a sale of more than a 50% interest,
the partnership has a technical termination and has to adjust its depreciation of assets.
Redemption. On a distribution from JIR to Julie in redemption of her interest, Julie recognizes a gain of
$100,000, which is classified as $50,000 of ordinary income and a $50,000 capital gain. Julie is deemed to
receive a § 736(a) payment of $50,000, including $40,000 for her share of unrealized receivables and $10,000
for unstated goodwill. (This result applies because Julie is treated as being a general partner in a
service-providing partnership, and the goodwill is not provided for in the partnership agreement.). The
remaining distribution of $150,000 is a § 736(b) payment in exchange for her interest in partnership property.
On this portion of the payment, Julie recognizes a capital gain of $50,000.
JIR deducts the $50,000 § 736(a) payment. In addition, JIR reflects a step up equal to the $50,000 capital gain
recognized by Julie.
Recommendation. In both situations, Irene and Rachel bear the burden of $100,000 of payment, and Julie
receives $200,000 of cash. Therefore, the preferred treatment hinges on the tax ramifications of the payments.
Under § 736, the partnership claims a deduction for $50,000 and a step up of $50,000 ($100,000 total). For a
sale of the interest, the step up is only $80,000 because the partnership’s inside basis is higher than Julie’s
outside basis. In addition, a step up can only be recovered through depreciation, amortization, or sale by the
partnership of an underlying asset. From Irene and Rachel’s perspective, the redemption is much preferred.
From Julie’s perspective, she reports $100,000 of gain in either situation. In the redemption, she has $10,000 of
additional ordinary income and $10,000 less of capital gain. The sale is slightly more favorable for her if capital
gains tax rates are preferable to ordinary income rates.
109. Your client has operated a sole proprietorship for several years, and is now interested in raising capital for
expansion. He is considering forming either a C corporation or an LLC.
a.
Describe the treatment of an LLC and discuss any advantages the LLC offers over the C corporation.
b.
Assume instead the client has previously operated as a C corporation. Describe the tax consequences of converting to an LLC.
a.
The limited liability company (LLC) generally provides for Federal taxation under Subchapter K (partnership taxation) and limited
liability for all owners. Therefore, it provides for the same protection from personal liability as a C corporation while providing for
taxation of LLC operations at the owner level. The C corporation tax does not apply to an LLC. Partnership provisions such as
optional adjustments to basis, special allocations of income, gain, loss, deduction and credit, and inclusion of all LLC liabilities in
outside basis are additional advantages of an LLC over a C corporation.
b.
An existing C corporation should carefully weigh the consequences before converting to an LLC. The IRS has ruled that a C
corporation must liquidate and re-form as an LLC. When a C corporation liquidates, any appreciation in corporate assets triggers a
corporate level gain. This results in immediate double taxation of the gain (at the corporate level, then as a shareholder gain or loss
on liquidation of the entity). [Note: In challenging economic times, this tax cost could be lower if asset values are depressed.] A
partnership, on the other hand, does not liquidate when it converts to an LLC, and any appreciation in partnership assets remains
untaxed.
Ka