Ch. 10 Answers to HW 11. a. A partners basis in the partnership interest must be adjusted in the order shown in Figure 10.

3: income items and contributions first increase basis, then basis is reduced by distributions from the partnership. Finally, losses may be deducted under 704(d) to the extent of any remaining basis. However, this allowed loss may be further limited under the at-risk and passive loss rules. In Brads case, the $20,000 distribution reduces his basis in the partnership interest to $0 and Brad must recognize a $5,000 gain (probably a capital gain) in the amount of the distribution that exceeds his $15,000 basis. Since his basis is reduced to $0, none of the loss can be deducted. The full $10,000 is suspended under 704(d) and must be carried forward until Brad has adequate basis to absorb the loss. If the partnership can make the distribution at the beginning of the following tax year, Brad could deduct the loss in the current year. The partnership expects to report earnings in future years, so Brads share of that income would increase his basis before the cash is distributed, and he will probably not be required to report a capital gain on the distribution. Alternatively, the partnership could incur additional (short-term) debt at the end of the year. This approach would be treated as a contribution of capital that increases Brads basis in his partnership interest. With adequate basis, the cash could be distributed without gain recognition, and the losses would be fully deductible. Figure 10.3 and Examples 28, 29, 37, and 38
14.

b.

c.

d.

a. b. c. d.

Under 721, neither the partnership nor the partners recognizes any gain on formation of the entity. Chip will take a cash basis of $200,000 in his partnership interest. Marty will take a substituted basis of $100,000 in his partnership interest ($100,000 basis in the property contributed to the entity). The partnership will take a carryover basis in the assets it receives ($200,000 basis in cash, and $100,000 basis in property).

Example 14 16. a. Carol realizes a gain of $20,000 on contribution of the land. Connie realizes a gain of $60,000 on contribution of the equipment. The partnership realizes a gain equal to the value of the property it receives (it has a $0 basis in the partnership interests it issues). Under 721, neither the partnership nor either of the partners recognizes any gain on formation of the entity. Example 8 Carol will take a substituted basis of $70,000 in her partnership interest ($30,000 cash plus $40,000 basis in land). Connie will take a substituted basis of $30,000 in her partnership interest ($30,000 basis in the equipment). Example 14

b. c.

d. e.

The partnership will take a carryover basis in all the assets it receives ($30,000 basis in cash, $40,000 basis in land, and $30,000 basis in equipment). p. 10-12 The partners outside bases in their partnership interests total $100,000: Carols basis of $70,000 plus Connies basis of $30,000. This is the same as the partnerships basis in assets of $100,000 ($30,000 cash plus $40,000 land plus $30,000 equipment). p. 10-14 The partnership will step into Connies shoes in determining its depreciation expense. It will use the remaining depreciable life and the same depreciation rates Connie would have used. p. 10-12 Assuming that Ericas capital account reflects an accurate number for basis purposes, the calculation is as follows: Capital account balance, beginning of year Share of EGs debt ($80,000 1/2) Ericas basis, beginning of year $120,000 40,000 $160,000

f.

27.

a.

b.

Capital account balance, beginning of year Add: Taxable income Tax-exempt interest income 1231 gain Long-term capital gain Less: Short-term capital loss Political contribution Charitable contribution Payment of Ericas medical expenses Cash distribution to Erica Plus: Share of EGs debt ($100,000 1/2) Ericas basis, end of year $70,000 1,000 2,000 500 $ 1,500 500 1,000 4,000 10,000

$120,000

73,500 $193,500

(17,000) $176,500 50,000 $226,500

Note that payment of Ericas medical costs is treated as a distribution to Erica. Also note that the political contribution decreases her basis even though Erica cannot deduct the expense. Examples 34 and 35, and Figure 10.3 Research Problem 3 a. Either June 30 or December 31 would be an acceptable year-end. Under 706(b)(1), the LLC (partnership) required taxable year is the first of the following that apply. majority interest taxable year. The same taxable year as all of the principal (5% or greater interest) partners. The year determined under the least aggregate deferral rules, as explained in the The regulations. The majority interest taxable year does not apply since neither of the LLC members has a majority interest (>50%) in the profits and capital of the LLC. ( 704(b)(4)(A)) Both Cameron and Totco are principal partners (5% or greater interests) in the CT, LLC, but since both members do not have the same taxable year, the principal partner rule does not apply. Therefore, CT, LLC must choose the taxable year that provides for the least aggregate deferral of income. To determine the required tax year of an LLC (partnership) under this method, perform the following steps. Select one partner's tax year as a test year. Calculate the number of months from the end of the test year to the next yearend for each partner (i.e., determine the number of deferral months for each partner). Multiply the number of income deferral months for each partner by each partner's profit percent. Add the products to determine the aggregate number of deferral months for the

test year. Repeat the process until each partner's tax year has been used as a test year. Compare the aggregate number of deferral months for each test year. test year that has the smallest number of aggregate deferral months is the The required tax year. TEST FOR 12/31 YEAR-END (Cameron's year-end) Months of Partner Year Ends Profit Interest Deferral Product Cameron 12/31 1/2 0 = 0.00 Totco, Inc. 6/30 1/2 6 = 3.00 Aggregate number of deferral months 3.00 10-48 2010 Annual Edition/Instructors Guide with Lecture Notes
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TEST FOR 6/30 YEAR-END (Totco, Inc.'s year-end) Months of Partner Year Ends Profit Interest Deferral Product Cameron 12/31 1/2 6 = 3.00 Totco, Inc. 6/30 1/2 0 = 0.00 Aggregate number of deferral months 3.00 Under the least aggregate deferral test, both a June 30 and December 31 year end provide for the same amount of deferral. Under regulations, if this calculation results in two taxable years with the same least aggregate deferral, the partnership may select either one of these taxable years as its taxable year. (Reg. 1.706-1(b)(3)(i)). b. If the partnership originally selected a June 30 taxable year, the year end of the LLC will remain June 30. The majority interest rule will now apply and Totco, Inc., a June 30 fiscal year taxpayer will own a majority (75%) interest in the LLC. If the partnership originally selected a December 31 taxable year, the taxable year of the LLC must change to June 30. Under Reg. 1.706-1(b)(8)(i)(A), a partnership has automatic approval from the IRS to make this change. If the year end changes again under the majority interest rule (e.g., if Totco, Inc. sells a portion of its interest to a calendar-year individual), the LLC will not be required to change its year again within two years after the initial change (Reg. 1.706-1(b)(8)(i)(C)). Under Reg. 1.706-1(b)(9), the December 31 partnership taxable year could be retained only if the LLC could get approval from the IRS for a natural business year or by making a 444 election. The problem states that CT does not have a natural business year. A 444 election is not available since the 6-month deferral from the required taxable year is greater than the maximum 3-month deferral permitted under 444. [ 444(b)(2)]. The change from a December 31 taxable year to a June 30 taxable year will be made under the provisions of Rev. Proc. 2006-46 (2006-45 IRB 859, 10/18/06).