introduction to partnership capital accountsmntaxclass.com/files/04_ch_4_prop_contr_to_php.pdf ·...
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Property Contributions to
Partnerships
Chapter 4
Introduction To Partnership
Capital Accounts
2
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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%
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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
Balance Sheet After Formation
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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
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505050
505050
The land is sold
for $1,000,000 at the end of Year 1
No other income or loss.
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IRC sec. 704(c) forces all $900K of the tax gain
to Alice
Zero Book Gain
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Alice’s K-1
$900,000
Alice’s Tax Basis Capital Accounts
$100,000
$900,000
$1,000,000
X
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Alice’s Book Basis Capital Accounts
$1,000,000
$0
$1,000,000
X
Assets: Tax Basis704(b)
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
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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
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$800,000 of tax gain to Alice
<$100,000> Book Loss split
50/50
Alice’s K-1
$800,000
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Bill is not allowed to deduct his
economic loss of <$50,000>
Assets: Tax Basis704(b)
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
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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:
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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
Balance Sheet After Formation
Alice’s Tax Basis Capital Accounts
$100,000
($200,000)
($100,000)
X
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Assets: Tax Basis704(b)
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
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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
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Assets: Tax Basis704(b)
Book BasisCash $1,200,000 $1,200,000Land $100,000 $1,000,000
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
Balance Sheet End of Yr 1
Alice’s K-1
$300,000
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Alice’s Tax Basis Capital Accounts
$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
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Alice’s Year 1 Ending OB:
$200,000 ($400,000 (Beg.) -
$200,000 loss)
Assets: Tax Basis704(b)
Book BasisCash $1,200,000 $1,200,000Land $100,000 $1,000,000
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
Balance Sheet End of Yr 1
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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?
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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
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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
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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
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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
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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
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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
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Subsequent Increases and Decreases in Outside Basis
Sec. 705
4-6
OrderingBeginning O.B.
+ Income (exempt also)
- Distributions- Losses= Ending O.B.
52
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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
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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
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$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
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<$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
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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
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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
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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
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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
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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
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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