Chapter 9 Tax Code

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General partner

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- Has the ability to make commitments for the partnership

- Each partner faces the risk of losing personal assets if the partnership incurs business losses

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Section 721

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Governs the formation of a partnership. In most cases, a partner who contributes property in exchange for a partnership interst recognizes no gain or loss on the transaction.

Likewise, the partnership recognizes no gain or loss on the contribution of property.

The partner's basis for his partnership interst and the parnership's basis for the property are both the same as basis of the property transferred.

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Section 721(a): General Rule

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Provides that neither the partnership nor any partner recognize a gain or loss when partners contribute property in exchange for a partnership interest

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Section 721(b):Exception #1

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You reconize gain when.. Contribution of property to a partnership that would be treated as an investment company if it were incorporated

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Section 707(a)(2) (A) and (B): Exception #2

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A property contribution followed by a distribution (or an allocation of income or gain) may be treated as a property sale by the partner to the partnership rather than as a contribution.

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Section 752: Exception #3

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Provides that two effects result from a partner's contribution of property to a partnership if the partnership also assumes the partner's liabilities:

1) Each partner's basis is increased by his share of the partnership's liabilities as if he or she had contributed cash to the partnership in the smount of his share of partnership liabilites

2) The partner whose personal liabilities are assumed by the partnership has a reduction in the basis of his partnership interest as if the partnership distributed csh to him or her in the amount of the assumed liability. A cash distribution first reduces the partner's basis in the partnership interest. If the cash distribution exceeds the partner's predistribution basis in the partnership interst, the partner recognizes gain.

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Section 723

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The partnership's basis for contributed property is the same as the property's basis in the hands of the contributing partner. If however, the contributing partner recognizes gain because the partnership is an investment company, such gain increases the partnership's basis in the contributed property. Gain recognized by the contributing partner because of the assumption of a partner's liability does not increase the partnership's basis in the property.

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Section 724

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Prevents the transformation of ordianry income into capital gains (or capital losses into ordinary losses) when a partner contributes property to a partnership. Properties that were (1) unrealized receivables, inventory, or capital loss property in the hands of the contributing partner and (2) contributed to a partnership retain their character for some subsequent partnership dispositions

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Unrealized recivable

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Is any right to payment for goods or services the holder has not included in income beacuse of the accounting method used. Most common is unrealized receivables is a cash basis taxpayer's A/R. Taxed as ordinary income.

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Section 1223(2)

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The partnership's holding period for its contributed assets includes the holding period of the contributing partner.

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Section 1245 and 1250 property rules

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The partner incurns no depreciation recapture unless he or she recognizes gain upon contributing property in exchange for a partnership interest. Instead, both the adjusted basis and depreciation recapture potential carry over to the partnership.

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Capital interest

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Can be valued by determining the amount the partner would receive if the partnership liquidated on the day the partner receives the partnership interest.

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Profit interest

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If the partner's only interst is in the furture earnings of the partnership (with no interst in the current partnership assets)

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Section 709

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Under Sec. 709, the partnership can elect to deduct the first $5,000 of capital expenditures in the tax year it begins business. As a limit, the partnership must reduce the 5,000 by the amount which cumulative organizational expenditures exceed $50,000, although the $5,000 can not be reduced below zero.

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Section 706(a)

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Each partner's tax return includes his or her share of partnership income, gain, loss, deduction, or credit items for any taxable year of the partnership ending within or with the partner's tax year

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Section 706

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1) Tax year-end used by the partners who own a majority interst (50% or more) in the partnerships capital and profits

2) The tax year-end used by all principle partners (5% or more interest)

3) The tax year-end determined by the least aggregate deferral test

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Least agregate deferal

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SUM of all Partners Ownership % times # of months the partner whould defer income

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Section 444

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Provides an election that permits a partnership to use a year-end that results in a deferral of the lesser of the current deferal period or thee months. This is available to both new partnerships makng an initial tax year election or existing partnerships that are changing tax years.

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Section 7519

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If a partnership makes a Sec. 444 election they must make a required payment under sec. 7519. The required payment has the effect of assessing a tax on the partnership's deferred income at the highest individual marginal tax rat plus one percentage point.

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Section 703(b)

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Requires that the partnership make all elections that can affect the computaiton of taxable income derived from the partnership.

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Section 703(a)

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Specifies a list of deductions available to individuals but that cannot be claimed by a partnership. The forbidden deductions include income taxes paid or accrued to a foreign country or U.S. possession, charitable contributions, oil and gas depletion, and net operating loss carrybacks or carryforwards.

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Section 702

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Requires that certain items be separately stated at the partnership level so thier character can remain intact at the partner reporting level.

As a general rule, an item must be separately stated if the income tax liability of any partner that would result from treating the item separately is different from the liability that would result if that item were included in the partnership ordinary income.

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Section 702(b)

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Requires that the character of each separately stated ite be determined at the partnership level. The amount then passes through to the paartners and is reported in each partner's return as if the partner directly realized the amount.

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Partnership U.S. production activities deduction

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- The deduction applies at the partner level, so the partnership must report each partner's share of qulaified production activities income on the partner's schedule K-1

- For the 50% salary limitation, each partner is allocated a share of the partnership's W-2 wages

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Sec. 704(b)

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The partner's distributive share normally is determined by the terms of th epartnership agreement or, if the partnership agreement is silent, by the partner's overall interest in the partnership as determined by taking into account all the facts and circumstances.

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partner's distributive share

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The portion of partnership taxable and nontaxable income that the partner has agreed to report for tax purposes

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Partnership agreement

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May discribe a partner's distributivve share by indicating the partners profits and loss interest, or it may indicate separate profits and loss interests

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Section 704

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Requires certain special allocations with respect to contributed property.

- Other spectial allocations are allowed as long as they meet the tests set forth in TR for having substantial economic effect.

1) The allocation results in the appropriate increase or dectese in partner's captial account

2) The proceeds of any liquidation occuring at any time in the partnership's life cycle are distributed in accordance with positive capital account balances.

3) Partners must make up negative balences in their capital accounts upon liquidation of the partnership, and these contibutions are used to pay partnership debts or are allocated to partners having positive capital account balances.

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Section 704(c)

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Requires precontribution gains or losses to contributing partner.

Income and deductions reported with respect to contributed property must be allocated to take into account the difference between the property's basis and FMV at the time of contribution.

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What are some of the common methods of acquireing a partnership interest, and what is the beginning basis?

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1) Contribution: Subsitituted basis from contributed property (TACT)

2) Purchase: FMV

3) Inheritance: FMV

4) Gift: usually donor's basis with a possible girt tax adjustment (TACT)

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Partner's basis in the partnership interst

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Partner's basis before changes in liabilities

PLUS: Increses in share of partnership liabilites

MINUS: Decreases in share of partnership liabilities

PLUS: Partnership liabilities assumed by this partner

MINUS: This partner's liabilities assumed by the partnership

= Partner's basis in the partnership interest

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Recourse loan

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The usual kind of loan for which the borrower remains liable until the loan is paid. If the recourse loan is secured and the borrower fails to make payments as scheduled, the lender can sell the property used as security. If the sales proceeds are insufficient to repay a recourse loan, the borrower must make up the difference. A recourse loan is one for which any partner or a related party will stand an economic loss if the partnership cannot pay the debt.

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Nonrecourse loan

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one in which the lender may sell property used as security if the loan is not paid, but no partner is liable for any deficiency. The lender has no recourse against the borrower for additional amounts.

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Section 752

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Require that recourse liabilities be allocated to the partner who will bear the economic loss if the partnership cannot pay the debt.

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Section 705

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Mandates a basis increase for additional contributions made by the partner to the partnership plus the partner's distributive share for the current and prior tax years of the following items:

1) Partnership taxable income (both separately stated items and partnership ordinary income)

2) Tax-exempt income of the partnership

Basis is decreased (but not below zero) by distributions from the partnership to the partner plus the partner's distributive share for the current and prior tax yearrs of the following items

1) Partnership losses (both separately stated items and partnership ordinary loss)

2) Expenditures that are not deductible for tax purposes and that are not capital expenditures

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Section 704 (d)

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The partner may not be able to use his full distributive share of losses because Sec. 704(d) limits a partner's loss deduction to the amount of his or her basis in the partnership interst before the loss.

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at-risk basis

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A partner is at risk for an amount if he would lose that amount should the partnership suddenly becomes worthless. Because a partner would not have to pay a partnership's nonrecourse liabilities even if the partnership became worthless, the usual nonrecause liabilities cannot be included in any partner's at risk basis

- At-risk rules do not apply to nonrecourse debt if it is qualified real estate financing.

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Section 469

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Losses of an individual partner from a passive activity cannot be used to offset either active incoe or portfolio income. However, passive losses carry over to furture years where they can offset passive income in thoses years. Passive losses are allowed in full when a taxpayer disposes of the entire interest in the passive activity. Passive losses generated by a passive rental activity in which an individual partner is an active participant can be deducted up to a maxmum of 25,000 per year.

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Section 707(b)

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Restricts sales of property between the partner and partnership by disallowing certain losses and converting certain capital gains into ordianary income

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Section 707(c)

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Permits a partnership to make guaranteed payments for capital and services to a partner that are separate from the partner's distributive share.

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Section 707(b)(1)

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- No loss can be deducted on the sale or exchange f property between a partnership and a person who disrectly or indirectly owns more than 50% of the partnership's capital or propfits interests.

- Losses are disallowed on sales or exchanges of property between two partnerships in which the same persons own, directly or indirectly, more than 50% of the capital of profits interests.

-If the seller is disallowed a loss under Sec. 707(b)(1), the purchaser can reduce any subsequent gain realized on a sale of the property by the previously disallowed loss.

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Section 707(b)(2)

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When a gain is recognized on the sale of a capital asset between a partnership and related partner, Sec. 707(b)(2) requires that the gain by ordinary (and not capital gain) iif the property will not be a capital asset to its new owner.

This applies to transfers between

1) a partnership and a person who owns, directly or indirectly, more than 50% of the parnership's capital or profits interest

2) two partnerships in which the same persons own, directly or indirectly, more than 50% of the capital or profits interests.

- This prevents related parties from increasing the depreciable basis of assets (and there by reducing future ordinary income) at the cost of recognizing only a current capital gain

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Section 707 (c)

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Guarantreed payment is a parners salary.

Guaraneed minimum-- if the distributive share is less than the guaranteed minimum, the guaranteed payment is the difference between the distributive share and the guaranteed minimum.

- GP are ordinary income to the recipient

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Section 704 (e)

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The someone is a partner in a family partnership if...

1) The partnership interst must be capital interest

2) capital must be a materail income-producing factor in the partnership's business activity

3) The family memeber must be the true owner of the interest

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Captial interst

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Gives the partner the right to recive assets if the partnership liquidates immediately upon the partner's acquisition of interest.

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Two requirements apply to doner-donee allocations: Section 704(e)(2)

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1) The donor must be allocated reasonable compensation for services rendered to the partnership

2) After reasonable compensation is allocated to the doner, any remaining partnership income must be allocated based on relative capital interests