Formation of Partnerships - Oelerich & Associates · I. Contributions of Property to a Partnership...
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17 - Formation of Partnerships 1
Page 333-359
I. Contributions of Propertyto a Partnership
The basics of partnership property contribution
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I. Contributions of Propertyto a Partnership
While there were gains and losses realized by the partner no recognition will occur at the time of the property contribution IRC 721(a)
Calvin WoodrowFMV Basis FMV Basis
Cash 50,000 50,000Trucks 150,000 80,000Tools 5,000 0Real Estate 155,000 105,000Pre-ContributionGain
$75,000 $50,000
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I. Contributions of Propertyto a Partnership
F. Document the capital contributions – create file worksheet
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II. Planning Opportunities –Triggering Gain or Loss
Be a planner not a box filler:Trigger gain if: Losses that could be offset during the year. Basis increases may be create tax advantages
in the futureTrigger losses if (This requires a 50% or less interest): Contributed property that has lost value over
time. Change in character of property
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III. Book Capital Accounts
A. This represents the BOOK records of the partnership
B. Maintained to comply with safe harbor rules of Reg. § 1.704-1(b) and used only by those partnerships required to deal with special allocations
C. Recorded at FMVD. Track ECONOMIC REALITY
Most partnerships are not required to maintain
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IV. Tax Capital Accounts
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IV. Tax Capital Accounts
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V. Other Capital Account Considerations (Excluding Debt)
B. Maintenance of the Capital Accounts
1. No assignment made by the code, regulations or even court cases
2. Identify the responsibilities as provided by partnership agreement but disclose in the engagement agreement
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C. The tax basis on the 1065 does not yield the partners basis in all cases
Chapter 17: Partnership (or LLC) Operations
10401065
V. Other Capital Account Considerations (Excluding Debt)
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V. Other Capital Account Considerations (Excluding Debt)
D. No balance sheet, no books what do we do?
Look at Regulation § 1.705-1(b)
Compute the partnership’s inside basis in all assets
Multiply that result by the partner’s percentage
THE RESULT IS AN ESTIMATE
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V. Other Capital Account Considerations (Excluding Debt)
How does the partner deal with the limitations and cost basis of their interest.
Must have been NO special allocations
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V. Other Capital Account Considerations (Excluding Debt)
A testament to why balance sheets should be kept
Sherry FredTax Basis 50% 50%
Cash $25,000 $12,500 $12,500Other Assets $60,000 $30,000 $30,000Total $85,000 $42,500 $42,500
Sale to John $25,000Loss on Sale -$17,500
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VII. Holding Period
D. A partner’s holding period will depend on the nature and character of asset contributed based on:
Inventory & Cash / FMV of Assets = S/TSection 1231 / FMV of Assets = L/TGain based on partners outside basis
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X. Determining the Availability of Suspended Losses
Add suspended losses to the contributing partners basis BUT they are not added to the basis in the hands of the partnership
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XIII. Tax Treatment of Service Partner
The letter of intent and cash was not created solely for the partnership however the design was
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The IRC 83(b) election – Some recent changes
T.D. 9779 Reg. § 1.83-2 – Effective date 1/1/2016 A copy of the election must be submitted to the IRS office
where the taxpayer’s return would be filed The election is no longer required to be attached to the
taxpayer’s return However, the election statement must be maintained by the
taxpayer during the statutory period
XIII. Tax Treatment of Service Partner
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Have your cake and eat it too – Services provided to partnership do not increase basis without a corresponding income recognition, i.e. there was no money.
XIII. Tax Treatment of Service Partner
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XIV. Transfers of Property to an Investment Company Partnership
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XV. Contributing AssetsSubject to Liabilities
Contributions of liabilities in excess of basis
• A debt relief issue and a debt assumption issue
• If net debt relief > basis taxable
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XV. Contributing AssetsSubject to Liabilities
Simple Math Basis – Debt Relief + Debt Assumption = Partner’s Basis in Contributed Property – Example Detail Following
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XV. Contributing AssetsSubject to Liabilities
Simple Math
Woodrow’s INSIDE BASISBasis in WarehouseLess: Total Debt ReliefNet Inside Basis
Woodrow’s OUTSIDE BASISTax Capital (Inside Basis)Debt BasisNet Outside Basis
$105,000$100,000
$5,000
$5,000$50,000$55,000
+ Basis– Debt Relief = Inside Basis
+ Inside Basis+ Debt Assumption = Outside Basis
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XV. Contributing AssetsSubject to Liabilities
What happens when net debtrelief exceeds the partner’s basisin the contributed property?
A taxable contribution and a ZERO tax basis
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XV. Contributing AssetsSubject to Liabilities
Not so simple math with debt in excess of basis
Woodrow’s INSIDE BASISBasis in WarehouseLess: Total Debt ReliefNet Inside Basis
Woodrow’s OUTSIDE BASISTax Capital (Inside Basis)Debt BasisNet Outside Basis
$20,000 $100,000 ($80,000)
($80,000)$50,000
($30,000)
+ Basis– Debt Relief = Inside Basis but not less than ZERO
+ Inside Basis+ Debt Assumption = Outside Basis
Taxable Amount $30,000
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XV. Contributing AssetsSubject to Liabilities
With Woodrow’s Taxable Event then the Partnership will increase the inside basis of the contributed property.
Woodrow’s capital account $-30,000Woodrow’s share of debt $30,000
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XVI. Character of Contributed Property
The possible tax trap not considered:
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XVI. Character of Contributed Property
C. The tax outcome of a future sale for a period of five years will be dependent in some cases of the nature of the asset in the hands of the contributor.
Inventory will be ordinary Capital Loss will be capital
The ordinary treatment of inventory will be for the entire gain incurred by the partnership
The capital loss will be to the extent unrealized by the contributor at the time of transfer
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XVII. Contributing Appreciated or Depreciated Property
B. Recapture on sale by the partnership must be allocated in a manner that recognizes Basis versus FMV on contribution
C. Built in loss property1. The built in loss is used solely to determine
allocation on sale2. The FMV at the time of transfer is the basis in
the hands of the partnership
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IRC 704c–Pre-Contribution Gain/Loss-The Basics
Why – to balance the differences between the INSIDE BASIS (aka tax basis) and BOOK CAPITAL (FMV) or property contributed to a partnership
TAX FMV
XVIII. Contribution of Property with Built in Gain or Loss
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A. Requires the allocation of gains or losses to bring TAX and BOOK into sync
1. Over time differences will disappear
2. “Gain/Loss” is allocated to contributing partner
B. IRC 704(c) meant to “prevent” the shifting of tax consequences among partners
XVIII. Contribution of Property with Built in Gain or Loss
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XVIII. Contribution of Property with Built in Gain or Loss
C. Method of allocation
1. The Traditional Method Reg. § 1.704-3(b) –Income to the partner with the built in gain
2. The Traditional Method with curative allocations Reg. § 1.704-3(c) – Income to the partner with the built in gain plus deductions to the other partners
3. The Remedial Allocation Method Reg. § 1.704-3(d) – Create Depreciation and Offsetting Income Allocations to cure
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704(c) Gain
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Page 348-349XVIII. Contribution of Property with
Built in Gain or Loss
XIX. Relief from 704(c) forSmall Disparities
Relief for small disparities –you can ignore it
Book versus adjusted basis variance is not greater than 15% for any tax year AND
The gross amount of variance is not greater than $20,000
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XIX. Allocations Using the Traditional Method Reg. § 1.704-3(b)
How can we “cure” built in gain under 704(c)?
Traditional method – Gain or losses are allocated to “contributing” partner upon taxable distribution of property.
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XX. Allocations Using the Traditional Method Reg. § 1.704-3(b)
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XX. Allocations Using the Traditional Method Reg. § 1.704-3(b)
Book (FMV) Tax (Inside)
Carol Bob Carol Bob
Cash 100,000 100,000
Land 100,000 60,000
Basis 100,000 100,000 100,000 60,000
Land Sale Gain
Basis
10,000 10,000 10,000 10,00040,000
110,000 110,000 110,000 110,000
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Chapter 17: Formation17 - Formation of Partnerships 51
Page 353XX. Allocations Using the Traditional
Method Reg. § 1.704-3(b)
Chapter 17: Formation
Book TaxCarol Bob Carol Bob
Cash/Equip 100,000 100,000 100,000 180,000
Accum Depr -128,160
Remaining Basis 100,000 100,000 100,000 51,840
Year 1Spec Allocated
Remaining Basis
Year 2Spec Allocated
Remaining Basis
Year 3Spec AllocatedRemaining Basis
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20,000 20,00020,000 736
80,000 80,000 80,000 51,10420,000 20,000
20,000 736
60,000 60,000 60,000 50,36810,000 10,000
10,000 368
50,000 50,000 50,000 50,00017 - Formation of Partnerships 52
XXI. Allocations Using the Traditional Method with Curative Allocations
Reg. § 1.704-3(c)
Traditional method with curative allocations –Allocates income, gains, losses and deductions in a “reasonable” manner to eliminate the differential
Subject to the ceiling rules
Examples in text
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XXII. Allocations Using the RemedialAllocation Method Reg. § 1.704-3(d)
Remedial Allocation Method – Creates artificial deductions/income to be “allocated” amongst partners
Relieves the issue of the ceiling rule that restricts the traditional method with curative allocations
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