Introduction To Partnership Capital Accountsmntaxclass.com/files/04_Ch_4_Prop_Contr_To_Php.pdf ·...

Property Contributions to

Partnerships

Chapter 4

Introduction To Partnership

Capital Accounts

2

3

The Importance of Tracking Tax and

Book Basis (IRC sec. 704(b))Capital Accounts

AB Partnership

Alice Bill

Land FMV $1,000,000Adj. Basis: $100,000

Cash $1,000,000

50%50%

Assets:704(b)

Book BasisCash $1,000,000Land $1,000,000

Total $2,000,000Capital:

Alice $1,000,000Bill $1,000,000

Debt + Capital $2,000,000

Balance Sheet After Formation

Assets: Tax Basis704(b)

Book BasisCash $1,000,000 $1,000,000Land $100,000 $1,000,000

Total $1,100,000 $2,000,000Capital:

Alice $100,000 $1,000,000Bill $1,000,000 $1,000,000

Debt + Capital $1,100,000 $2,000,000


Alice’s Tax Basis Capital Accounts

$100,000

$0

$100,000

X

Alice’s 704(b) Capital Accounts

$1,000,000

$0

$1,000,000

X

505050

505050

The land is sold

for $1,000,000 at the end of Year 1

No other income or loss.

IRC sec. 704(c) forces all $900K of the tax gain

to Alice

Zero Book Gain

Alice’s K-1

$900,000


$100,000

$900,000

$1,000,000

X

Alice’s Book Basis Capital Accounts

$1,000,000

$0

$1,000,000

X


Book BasisCash $2,000,000 $2,000,000

Capital:Alice $1,000,000 $1,000,000Bill $1,000,000 $1,000,000

Debt + Capital $2,000,000 $2,000,000

Balance Sheet Following Sale

The land is sold

for $900,000 at the end of Year 1

(no other income or loss)

Use the traditional method of

allocating IRC sec. 704(c) gain

$800,000 of tax gain to Alice

<$100,000> Book Loss split

50/50

Alice’s K-1

$800,000

Bill is not allowed to deduct his

economic loss of <$50,000>


Book BasisCash $1,900,000 $1,900,000

Capital:Alice $900,000 $950,000Bill $1,000,000 $950,000

Debt + Capital $1,900,000 $1,900,000

Balance Sheet Following Sale

If, next, the partnership liquidated and distributed the cash $950,000 to each partner:

$50,000 Alice’s Rec. Gain

<$50,000> Bill’s Rec. Loss

Net Rental Loss of

$400,000In Year 1(no sale)

Restart from formation:



Total $1,100,000 $2,000,000Capital:

Alice $100,000 $1,000,000Bill $1,000,000 $1,000,000

Debt + Capital $1,100,000 $2,000,000



$100,000

($200,000)

($100,000)

X


Book BasisCash $600,000 $600,000Land $100,000 $1,000,000

Total $700,000 $1,600,000Capital:

Alice -$100,000 $800,000Bill $800,000 $800,000

Debt + Capital $700,000 $1,600,000

Balance Sheet End of Yr 1

$100,000 of Alice’s loss is

suspended due to insufficient outside basis

Alice’s 704(b) Capital Accounts

$1,000,000

($200,000)

$800,000

X

Partnership Borrowed$600,000

Before Year End(50% to A; 50% to B)

Additional Yr. 1 FactsWith Yr. 1 Loss



Total $1,300,000 $2,200,000Debt 600,000 600,000Capital:

Alice -$100,000 $800,000Bill $800,000 $800,000

Debt + Capital $1,300,000 $2,200,000


Alice’s K-1

$300,000


$100,000

($200,000)

($100,000)

X

Alice’s pre-loss O.B. is $400,000:

$100,000 Capital+$300,000 Debt

Alice has sufficient O.B. to claim $200,000 loss

Alice’s Year 1 Ending OB:

$200,000 ($400,000 (Beg.) -

$200,000 loss)



Total $1,300,000 $2,200,000Debt 600,000 600,000Capital:

Alice -$100,000 $800,000Bill $800,000 $800,000

Debt + Capital $1,300,000 $2,200,000


Compare an S corporation

Losses are limited to stock and debt basis

Can the partnership report tax basis

Schedule L and put book basis capital accounts on the

Sch. M-2 and Partners’ K-1s?

Schedule M-2 Instructions

Example 4-2 4-5

Alice contributes land to a partnership in exchange for a 20% partnership interest:

$10,000 FMV$4,000 Adjusted Basis

40

Example 4-2 4-5

No gain recognition for Alice (Sec. 721)

Alice’s outside basis = $4,000 (Sec. 722)

Partnership’s inside basis = $4,000 (Sec. 723)

Alice’s beginning Sec. 704(b) “capital account” is $10,000.

41

What if the partnership had total recourse debt of $10,000 so that Alice is, in effect, responsible for $2,000 (20%) of the partnership debt(Sec. 752 simplified).

42

Impact of Partnership Debt

A net increase in a partner’s share of debt is a deemed contribution of money by the partner.(Sec. 752)43

The impact of the net debt assumption $2,000 is that Alice’s outside basis is increased by the $2,000:

$4,000 basis of contrib. prop.+$2,000 deemed cash contrib.=$6,000 Alice’s outside basis.

44

Example 4-2 (original facts)

If the land were sold by the partnership for $10,000, how much of the $6,000 recognized tax gain would be allocated to Alice?45

Example 4-2 4-5

$6,000 (Sec. 704(c))

46

If the land were sold by the partnership for $10,000, does the partnership have any Sec. 704(b) book gain?

47

No Book GainBook basis of contributed property is FMV (Sec. 704(b)). (zero book gain).

The Sec. 704(c) allocation of the $6,000 tax gain to Alice causes her tax basis equity to catch up with her $10,000 capital account.48

If the land were sold by the partnership for $20,000, how much of the $16,000 ($20,000 -$4,000) recognized tax gain would be allocated to Alice on her K-1?49

$8,000 is Allocated to Alice:

$6,000 (first $6K)*+ $2,000 (20% x $10K)**= $8,000

* Sec. 704(c) tax gain 6K** Sec. 704(b) tax & book

gain of 10K50

Subsequent Increases and Decreases in Outside Basis

Sec. 705

4-6

OrderingBeginning O.B.

+ Income (exempt also)

- Distributions- Losses= Ending O.B.

52

Alice – New Facts

What if Alice received a distribution of $10,000 cash from the partnership when her pre-distribution outside basis is $4,000? 53

$6,000 of gain (Sec. 731(a)(1)

54

Alice – New Facts

What if Alice’s share of partnership debt is reduced by $10,000 when her pre-distribution outside basis is $4,000? 55

Impact of Partnership Debt

A net decrease in a partner’s share of partnership debt is a deemed distribution of money to the partner. (Sec. 752)56

$6,000 of gain (Sec. 731(a)(1)

57

The gain does not directly show on K-1

Does not increase outside basisDoes increase at-risk basis

Alice (New Facts)

What if Alice is properly allocated losses of <$10,000> when her post-distribution outside basis is $4,000? 58

<$4,000> deducted (IRC sec. 704(d))

<$6,000> suspended

59

Alice (New Facts)

$4,000 Beginning O.B.

Alice’s K-1:<$7,000> Losses

$3,000 Cash Distribution

60

OrderingBeginning O.B.

+ Income- Distributions- Losses= Ending O.B.

61

$3,000 distribution reduces her outside basis to $1,000 ($4,000 O.B. - $3,000 distribution).

<$1,000> loss is deductible

<$6,000> losses are suspended.

62

Contribution of Property Subject to Recourse Debt

Reg. 1.752-1

4-8

Alice contributes land to a corporation for 20% of the stock (assume Sec. 351 applies):

$10,000 FMV$4,000 Adjusted Basis$6,000 Recourse Debt

64

S (or C) Corporation Example

Although she is protected by Sec. 351, she must recognize $2,000 of gain under Sec. 357(c)—debt relief in excess of her total basis in total contributed property ($6,000 - $4,000).

65

Example 4-6

Alice contributes land to partnership for 20% interest:

$10,000 FMV$4,000 Adjusted Basis$6,000 Recourse Debt

66

4-9

Example 4-6

Alice’s remaining outside basis (O.B.):

$4,000 A.B. of Land-$4,800 Debt (80%) Allocated to other Ps$ 0 Ending O.B.

Gain of $800 (Cash in excess of O.B.)

67

4-9

Contribution of Property Subject to Nonrecourse

Debt

Reg. 1.752-3

4-9

Example 4-7

Alice contributes land to partnership for 20% interest:

$10,000 FMV$4,000 Adjusted Basis$6,000 Non-Recourse Debt

69

4-10

Example 4-7

Alice’s share of the $6,000 nonrecourse debt is $2,800:

Tier One: Zero (no minimum gain)

Tier Two: $2,000 ($6,000 (debt) -$4,000 (land adjusted basis))

Tier Three: $800 (($6,000 (debt) -$2,000 (tier two allocation)) x 20%)70

4-11

Example 4-7

Alice’s remaining outside basis (O.B.):

$4,000 A.B. of Land-$3,200 Debt Allocated to other Ps$ 800 Alice’s O.B.

Zero Gain Recognized

71

4-11

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