Partnerships, Real
Estate, and
Selected Basis
Issues
Bill Johnson, CPA, ABV
Jeff Olson, CPA
Babush, Neiman, Kornman &
Johnson, LLP
www.bnkj.com
A Universal Given????

Cost = Basis
or, to say it another way,
Basis = Cost
 Is either just what was paid?
 What is “cost basis”?
What’s the Big Deal About
Basis?????
Transaction economics and tax
accounting may differ! Why?
Transactions
negotiated on fair
value
Tax accounting may record them at
something other than negotiated
value


Carry over cost basis (as in 1031
exchanges with deferred gain)
But, not always
What’s the Big Deal About
Basis?????
It effects reported gain

Who reports it
 How much
What is Cost?
Seems simple, but that depends:

Whose cost?
The partner’s or the partnership’s
 Inside basis/outside basis


Depending on which you mean,
then you have to determine
 Is
it reflected, or not, on the
partnership’s books/tax records?
Partnership Basis Topics

IRC Code Sections 721/704
and 754



Only an overview
It is very complex
What gives rise to these
complicated tax accounting
rules?
 Can tax basis presentations
ever have any useful meaning
if they are not always based on
the value/economics of a deal?
Problem Cause #1
A Partner’s contribution of
property to, or distributions
from, a partnership generally do
not trigger a recognizable tax
event - Section 721

This is generally a good thing deferred recognition of appreciation
gains
 It just screws up the tax accounting
relative to the “deal” economics
Basic Example - No Issues
Example 1: 50/50 partnership:
Partners contribute cash to buy assets-partnership cost
Partnship develops, leases sells-sales proceeds
Gain
Distributions per partner
Less what they put in
Gain per partner
-2,000
3,000
1,000
1,500
(1,000)
500
Basic Example - 721 Issue
Example 2: 50/50 partnership, $500 carryover basis:
Partner 1 contributes appreciated land - value = $1,000 (500)
Partner 2 contributes cash for improvements
(1,000)
Partnship develops, leases sells-sales proceeds
3,000
Gain
1,500
Distributions per partner
Less what they put in at value
Gain per partner
Whoops, that is a total gain of only
Extra gain???? Does partner 2 report any?
1,500
(1,000)
500
1,000
500
Basic Example - 721 Issue
Comparative balance sheets:
Straight tax basis
Real estate
Exple. 1
Exple. 2
2,000 1,500
Capital Partner 1
Capital Partner 2
Total capital
1,000
500
1,000 1,000
2,000 1,500
Improved presentation
Real estate
704(c) asset
Total assets
2,000 1,500
500
2,000 2,000
Capital Partner 1
Capital Partner 2
704(c) equity-deferred gain to Partner 1
Total capital
1,000
500
1,000 1,000
500
1,000 2,000
Assets Subject to Debt
Other potential complications
 What
if the asset is not sold, but
held for rental and depreciated?
 What if only part of the project is
sold in a tax year?
●
What cost is being depreciated?
● How is it allocated among the partners?
Complex Example - 721 Issue
Example 3: 50/50 partnership, but contributed assets subject to debt :
3-A
Land contributed - carry over basis
500
704(c) asset
500
Improvements funded with Partner 2 capital
1,000
Total assets
2,000
Assumed debt
Partner 1 capital-carryover basis (land less debt assumed)
Partner 2 capital
704(c) equity
Total equity
750
(250)
1,000
500
2,000
Assets Subject to Debt
Contributions of assets subject to
debt can trigger recognizable gain
to the contributing partner

But limited to the proportion of the
debt shifted to other partners
 Up to the debt in excess of his
basis in the contributed asset
Assets Subject to Debt
Example 3: 50/50 partnership, but contributed assets subject to debt :
Calculation of gain recognition
Debt relieved/assumed
Contributor basis in assets
Excess (negative contribution/recognized gain)
Debt
100%
Shifted
750
375
(500)
(250)
250
125
Gain recognized by contributing partner increases his basis in the asset
and decreases his deferred gain---Section 754 election.
Complex Example - 721 Issue
Example 3: 50/50 partnership, but contributed assets subject to debt :
3-A
Land contributed - carry over basis + gain recognized
500
704(c) asset
500
Improvements funded with Partner 2 capital
1,000
Total assets
2,000
Assumed debt
Partner 1 capital-carryover basis (land less debt assumed)
Partner 2 capital
704(c) equity
Total equity
750
(250)
1,000
500
2,000
3-B
625
375
1,000
2,000
750
(125)
1,000
375
2,000
The Problem Cause #2
Transactions between
partners may give rise to
accounting on the
partnership’s books:
 Home
Depot example
 Partnerships are different!
Example 754 Issue
Sale of partnership interest
 Assets
are adjusted upward
(stepped up) to account for the
value paid by the new partner
 The purchase value of a new
partner’s interest is “pushed
down” to the partnership
 Partner’s capital account at the
date of contribution equals his
purchase price
Example 754 Issue
Example 4: 50/50 partnership, sale of partnership interest:
Assets
Partner 1 capital
Partner 2 capital
New partner 3 capital - 754 election
Total capital
Old
2,000
New
2,250
1,000
1,000
0
2,000
1,000
0
1,250
2,250
Section 754 Effects
Acquiring partner’s stepped up
basis gives appropriately larger
depreciation deductions to that
partner
 Upon sale, increased basis reduces
gain recognizable to that partner
 Former partners are unaffected
 Only a proportionate step up --- not
to 100% of asset values as in
704(c)

Contribution of Development
Fees

Contribution of services,
immediate capital account
credit (capital interest)
●

equals immediate taxable
income---ordinary
Distribution priority (future
profits interest)
●
●
No immediate tax event
If partnership gains are capital,
then some of the “services”
treated as capital gain