Ch. 21 Pre-test - Partnerships

A partnership measures and reports two kinds of income: ordinary (operating) income and investment income.

False. A partnership measures and reports two kinds of income: ordinary (operating) income and separately stated items.

A partner's basis is reported on the Schedule K-1.

False. A partner's basis is not reflected anywhere on the Schedule K-1. Instead, each partner should maintain a personal record of the basis in the partnership interest.

If a partnership converts to an LLC, there are numerous tax ramifications.

False. A partnership can convert to an LLC with few, if any, tax ramifications: the old elections of the partnership continue, and the partners retain their bases and ownership interests in the new entity.

One of the advantages of an LLC is the abundance of case law interpreting the various state statutes.

False. One disadvantage of an LLC stems primarily from the lack of final Regulations in certain areas. There is only a limited body of case law interpreting the various state statutes, so the application of some provisions is uncertain. An additional uncertainty for LLCs that operate in more than one jurisdiction is which state's law will prevail and how it will be applied.

Even if the partnership properly makes an election for treatment of a specific tax item, the partner may elect out of that treatment.

False. The partnership makes elections regarding everything from the partnership's taxable year to the depreciation method for partnership assets. Each partner is bound by the decisions made by the partnership relative to these partnership level elections.

A marketable security generally is treated as property rather than cash for purposes of the partnership distribution rules.

False. A marketable security generally is treated as cash rather than property for purposes of the partnership distribution rules. The result is that a marketable security distribution can create a recognized gain for the distributee partner if the partnership's basis in the security is greater than the partner's basis in the partnership interest.

Each partner has an inside basis for each asset the partnership owns.

False. A partnership has an inside basis for each asset it owns, and each partner has an outside basis in the partnership interest.

Because the Code doesn't define "tax shelter," the IRS must judge whether any given partnership is a tax shelter on a case-by-case basis.

False. A tax shelter is a partnership whose interests have been sold in a registered offering or a partnership in which 35 percent of the losses are allocated to limited partners.

As a special allowance, individuals can offset up to $50,000 of passive activity losses from rental real estate against active and portfolio income.

False. As a special allowance, individuals can offset up to $25,000 of passive activity losses from rental real estate against active and portfolio income. (This amount is phased out starting at $100,000 of modified adjusted gross income.) This deduction is available to those who actively (rather than materially) participate in rental real estate activities.

Stork Partnership incurred $15,000 of organizational costs and $75,000 of startup costs in 2017. Stork may deduct $5,000 each of organizational and startup costs, and the remaining costs ($10,000 of organizational costs and $70,000 of startup costs) may be amortized over 180 months.

False. For organizational and startup costs, the first $5,000 may be deducted, provided total expenses in that category do not exceed $50,000. If costs in the category exceed the base amount, the deduction is phased out, dollar for dollar. When costs exceed the phaseout amount in that category, no portion of the current deduction is permitted. Any amount that may not be deducted is amortized over 180 months.

If a partner contributes appreciated property to a partnership, the contributing partner recognizes gain if the property is distributed to another partner within ten years of the contribution date.

False. If a partner contributes appreciated property to a partnership, the contributing partner recognizes gain if the contributed appreciated property is distributed to another partner within seven years of the contribution date.

If a partnership makes a payment on behalf of a partner for medical expenses, the partnership can deduct the payment as a medical expense.

False. If a partnership makes a payment on behalf of a partner, such as for alimony, medical expenses, or other items that constitute deductions to individuals, the partnership treats the payment as a distribution or guaranteed payment to the partner, and the partner determines whether to claim the deduction.

If the partners owning more than 50 percent of a partnership's capital and profits have the same tax year, then the partnership will not use the tax year of these majority partners.

False. If the partners owning more than 50 percent of a partnership's capital and profits have the same tax year, then the partnership uses the tax year of these majority partners. This is the first of three rules used to determine a partnership's required tax year.

In a proportionate liquidating distribution, unrealized receivables and inventory are distributed first.

False. In a proportionate liquidating distribution, cash is distributed first, followed by unrealized receivables and inventory.

Meredith and Katie form an equal partnership during the current year. Meredith contributes cash of $160,000, and Katie contributes property (adjusted basis of $90,000, fair market value of $260,000) subject to a nonrecourse liability of $100,000. As a result of these transactions, Katie has a basis in her partnership interest of $40,000.

False. Katie is allocated the first $10,000 of debt ($100,000 debt - $90,000 basis), plus one-half of the remaining debt. She has an adjusted basis for her partnership interest of $45,000, calculated as follows: Basis, property transferred $90,000 Less: liability assumed by partnership (100,000) Plus: § 704(c) allocation of debt 10,000 Basis before remaining allocation $-0- Remaining allocation of debt ($90,000 × 50%) 45,000 Katie's basis = $45,000

Losses that cannot be deducted because of the basis limitation are carried back for two years.

False. Losses that cannot be deducted because of the basis limitation are suspended and carried forward (never back) for use against future increases in the partner's adjusted basis.

Nonrecourse debt is allocated based on each partner's economic risk of loss.

False. Nonrecourse debt (including qualified nonrecourse financing) is allocated among all the partners. It is generally allocated to the partners in accordance with their profit sharing ratios.

All payments from a partnership to a partner are treated as distributions.

False. Not all payments from a partnership to a partner are treated as distributions. One example of a payment not considered a distribution is rent paid by a partnership to a partner.

Items that are not required to be passed through separately from a partnership to the partners include charitable contributions and taxes paid to foreign countries.

False. Partnership income and loss items must be separately stated if they could differently affect the tax liabilities of two or more partners. This is true also for other partnership items and information (not necessarily income or loss amounts), such as charitable contributions and the information a partner might need for calculating the foreign tax credit.

If a partnership allocates losses to the partners, the partners must first apply the at-risk limitations, then the basis limitation, and finally the passive loss limitations. If all three hurdles are met, the partner may deduct the loss.

False. The overall limitation of § 704(d) must first be met. This means the allocated loss cannot exceed the partners' basis in the partnership interest. Any loss that meets the overall limitation must be tested under the at-risk rules of § 465. Any losses that pass the at-risk rules are evaluated. If the loss is a passive loss under § 469, it is combined with passive income and losses from other sources to determine whether or not it may be deducted. If a loss passes these three limitations, a noncorporate taxpayer must consider whether the excess business loss limitation might apply.

The partner's basis is shown on Schedule K-1.

False. The partner's basis is NOT shown on Schedule K-1 or anywhere else on the tax return.

Peter's basis in his partnership interest is $100,000, including his share of partnership debt. Cheyenne buys Peter's partnership interest for $60,000 cash, and she assumes Peter's $60,000 share of the partnership's debt. If the partnership owns no hot assets, Peter will recognize a capital loss of $40,000.

False. The partner's share of partnership debt is included in both the partner's basis in the partnership interest and in the proceeds received on the sale. Peter's sales price for the interest is $120,000 ($60,000 cash + $60,000 assumption of partnership debt). Since his basis was $100,000, he realizes a capital gain of $20,000.

The partnership is required to issue a Schedule K-1 to the selling partner within sixty days of the sale of the partnership interest.

False. The partnership is not required to issue a Schedule K-1 to the selling partner until the normal filing of its tax return.

A proportionate distribution occurs when the distribution increases or decreases the distributee partner's interest in certain ordinary income-producing assets.

False. This describes a disproportionate distribution.

A liquidating distribution can consist of cash or partnership property.

True.

A partnership may allocate items of partnership income, gain, loss, deduction, or credit in any manner agreed upon by the partners, provided the allocation meets the three substantial economic effect tests or certain alternate tests for economic performance.

True.

A tax shelter is a partnership whose interests have been sold in a registered offering or a partnership in which 35 percent of the losses are allocated to limited partners.

True.

An example of the "aggregate concept" underlying partnership taxation is the fact that the partners (rather than the partnership) pay tax on partnership income.

True.

For property (or cash) contributed to the partnership, the adjusted basis is used, not the fair market value.

True.

If the loss is a passive loss under § 469, it is combined with passive income and losses from other sources to determine whether or not it may be deducted.

True.

If the transferee sells the property at a gain, the disallowed loss reduces the gain the transferee would otherwise recognize.

True.

Recourse debt is partnership debt for which the partnership or at least one of the partners is personally liable.

True.

The cash method may not be adopted by a partnership that has one or more C corporation partners.

True.

Making a tax-deferred contribution of an asset to the capital of a partnership can have negative tax consequences.

True. Potential partners should be cautious in transferring assets to a partnership to ensure that they are not required to recognize any gain upon the creation of the entity. When a partner makes a tax-deferred contribution of an asset to the capital of a partnership, any potential gain or loss recognition is merely postponed, instead of being permanently excluded.

A limited liability partnership does not have to pay state franchise taxes on its operations.

True. This is an important difference between LLPs and LLCs in states that impose franchise taxes on LLCs.

A partner can make a tax-deferred contribution of assets to the partnership after its inception.

True. A partner can make a tax-deferred contribution of assets to the entity either at the inception of the partnership or later. This possibility is not available to less-than-controlling shareholders in a corporation.

Partnership taxable income and any separately stated items flows through to each partner at the end of the partnership's taxable year.

True. A partner's taxable income, then, includes the distributive share of partnership income for any partnership taxable year that ends during the partner's tax year.

A partnership is an association formed by two or more persons to carry on a trade or business.

True. A partnership is defined as an association formed by two or more persons to carry on a trade or business, with each contributing money, property, labor, or skill, and with all expecting to share in profits and losses. A "person" can be an individual, trust, estate, corporation, association, or another partnership.

One of the advantages of the partnership form over the Subchapter C corporation is the reduction of double taxation.

True. A partnership is subject to only a single level of taxation. Corporate income, however, is taxed at the entity level and upon distribution to corporate owners as dividends.

The LLP is currently the organizational form of choice for professional service entities, such as accounting firms.

True. An LLP partner is not personally liable for any malpractice committed by other partners. The LLP is currently the organizational form of choice for the large accounting firms.

Partners in a registered limited liability partnership are not personally liable for the malpractice and torts of their partners.

True. As a result, the exposure of their personal assets to lawsuits filed against other partners and the partnership is considerably reduced.

A partner can contribute capital to the partnership before the end of the tax year to ensure there is adequate basis to absorb the loss.

True. If a partnership incurs a loss for the taxable year, careful planning will help ensure that the partners can claim the deduction. A partner can contribute capital to the partnership before the end of the tax year to ensure there is adequate basis to absorb the loss.

Distributions don't typically cause the partner to recognize income or gain.

True. Instead, the partner's outside basis is reduced by the amount of cash received.

Partnership taxable income and any separately stated items flows through to each partner at the end of the partnership's taxable year.

True. Partnership taxable income (and any separately stated items) flows through to each partner at the end of the partnership's taxable year. A partner's taxable income, then, includes the distributive share of partnership income for any partnership taxable year that ends during the partner's tax year.

Rent income from real or personal property generally is passive activity income.

True. Rent income from real or personal property generally is passive activity income, regardless of the partner's level of participation. The primary exception is that rental real estate is not treated as a passive activity for a person who qualifies as a real estate professional.

The capital account analysis is shown on the partner's K-1.

True. The capital account analysis (sometimes called a "rollforward" or "reconciliation") is shown on the partner's Schedule K-1. This calculation shows the change in the partner's capital account from the beginning to the end of the tax year.

No loss is recognized on a sale of property between a person and a partnership when the person owns, directly or indirectly, more than 50 percent of partnership capital or profits.

True. The disallowed loss might not vanish entirely, however. If the transferee eventually sells the property at a gain, the disallowed loss reduces the gain the transferee would otherwise recognize.

The purchasing partner includes any assumed indebtedness as part of the consideration paid for the partnership interest.

True. The purchasing partner includes any assumed indebtedness as a part of the consideration paid for the partnership interest, just as the selling partner includes the share of liabilities in the basis in the partnership interest.

In a proportionate liquidating distribution, Arline receives a distribution of $40,000 cash, accounts receivable (basis of $0 and fair market value of $20,000), and land (basis of $20,000 and fair market value of $30,000). In addition, the partnership repays all liabilities, of which Arline's share was $40,000. Arline's basis in the entity immediately before the distribution was $50,000. As a result of the distribution, what is Arline's basis in the accounts receivable and land, and how much gain or loss does she recognize? a. $0 basis in accounts receivable; $0 basis in land; $30,000 gain. b. $0 basis in accounts receivable; $10,000 basis in land; $0 gain or loss. c. $20,000 basis in accounts receivable; $30,000 basis in land; $80,000 gain. d. $0 basis in accounts receivable; $20,000 basis in land; $0 gain or loss. e. $20,000 basis in accounts receivable; $30,000 basis in land; $40,000 gain.

a. $0 basis in accounts receivable; $0 basis in land; $30,000 gain. Arline's basis in the interest is first reduced by the $40,000 cash distribution and the $40,000 repayment of liabilities (treated as a cash distribution). These distributions exceed Arline's basis and trigger recognition of a $30,000 gain. The accounts receivable and land must take a $0 basis because there is no remaining basis in Arline's interest.

Isabel is a 40 percent partner in the ICE Partnership. During the current year, ICE reported gross receipts of $160,000 and a charitable contribution of $10,000. The partnership paid office expenses of $100,000. In addition, ICE distributed $10,000 each to partners Isabel and Edith, and the partnership paid partner Tonya $20,000 for administrative services. Isabel reports which of the following income from ICE during the current tax year? a. $16,000 ordinary income; $4,000 charitable contribution. b. $12,000 ordinary income. c. $8,000 ordinary income; $4,000 charitable contribution. d. $4,000 ordinary income. e. None of these choices are correct.

a. $16,000 ordinary income; $4,000 charitable contribution. ICE's net ordinary income is $40,000 ($160,000 ordinary income - $100,000 of office expenses - $20,000 payment to Tonya). The cash distributions to Isabel and Edith are not deductible. Isabel's share of this income is $16,000. In addition, Isabel reports her $4,000 share of the partnership's charitable contribution.

Pita is a limited partner in the PIE Partnership, which is not publicly traded. Her allocable share of PIE's passive ordinary losses from a nonrealty activity for the current year is ($60,000). Pita has a $40,000 adjusted basis (outside basis) for her interest in PIE (before deduction of any of the passive losses). Her amount "at risk" under § 465 is $30,000 (before deduction of any of the passive losses). She also has $25,000 of passive income from other sources. How much of her ($60,000) allocable loss can Pita deduct on her current year's tax return? a. $25,000. b. $60,000. c. $30,000. d. $40,000. e. None of these choices are correct.

a. $25,000. The $60,000 passive loss must be limited first by Pita's $40,000 outside basis for her partnership interest. The "at risk" rules further limit her deduction to $30,000, the amount she is "at risk" in PIE. She can deduct $25,000 of this loss because that is the amount she has of passive income from other sources.

Tempe LLC incurred the following costs during its first year: Legal fees for drafting the operating agreement $18,000 Syndication costs $19,000 Preopening advertising expenses $20,000 Accounting fees for tax advice of an organizational nature $15,000 Training costs for new employees before opening the business $12,000 The amount of Tempe's startup costs is: a. $32,000. b. $37,000. c. $84,000. d. $39,000. e. $69,000.

a. $32,000. Startup costs include the pre-opening advertising expenses and the training costs for new employees before opening the business ($20,000 + $12,000 = $32,000). The legal fees and accounting fees are organizational costs.

Opal receives a proportionate liquidating distribution when the basis of her partnership interest is $20,000. The distribution consists of $25,000 cash and noninventory property (adjusted basis to the partnership of $10,000 and fair market value of $12,000). The partnership has no hot assets. How much gain or loss does Opal recognize, and what is her basis in the distributed property? a. $5,000 capital gain; $0 basis in property. b. $0 gain or loss; $12,000 basis in property. c. $5,000 ordinary income; $0 basis in property. d. $5,000 capital gain; $10,000 basis in property. e. $0 gain or loss; $10,000 basis in property.

a. $5,000 capital gain; $0 basis in property. Opal's $20,000 basis is first reduced by the $25,000 cash distribution she receives, which results in a $5,000 capital gain (because the partnership has no hot assets). After this distribution, Opal's basis is $0. When the remaining partnership property is distributed, it also takes a $0 basis

On January 1 of the current year, Annabelle and Paul form an equal partnership. Annabelle makes a cash contribution of $80,000 and a property contribution (adjusted basis of $120,000; fair market value of $160,000) in exchange for her interest in the partnership. Paul contributes property (adjusted basis of $190,000; fair market value of $240,000) in exchange for his partnership interest. Which of the following statements is true concerning the income tax results of this partnership formation? a. Annabelle has a $200,000 tax basis for her partnership interest. b. The partnership has a $160,000 adjusted basis in the property contributed by Annabelle. c. Paul recognizes a $50,000 gain on his property transfer. d. Paul has a $240,000 tax basis for his partnership interest. e. None of these choices are correct.

a. Annabelle has a $200,000 tax basis for her partnership interest. The contributions are tax-free, and the carryover and substituted basis rules of §§ 722 and 723 apply. Paul's basis for his partnership interest will be the same as his $190,000 basis for the property contributed. Annabelle will have a $200,000 tax basis for her partnership interest ($80,000 cash contributed plus $120,000 adjusted basis of the property contributed); the partnership will have a $120,000 adjusted basis for the property contributed by Annabelle; and neither Paul nor Annabelle will recognize a gain or loss on the property contribution.

Swift, Inc., Heron, Inc., and Canary formed a general partnership. Swift owns a 50 percent interest, and Heron and Canary each own 25 percent interests. Swift, Inc., files its tax return on a July 1-June 30 fiscal year; Heron, Inc., files on a September 1-August 31 fiscal year; and Canary is a calendar year taxpayer. Which of the following statements is true regarding the taxable year the partnership can choose? a. The partnership can request permission from the IRS to use a January 31 fiscal year if it can establish that is a natural business year. b. The partnership must choose a June 30 year-end because Swift, Inc., is a majority partner. c. The partnership cannot use the "least aggregate deferral" method to determine its taxable year. d. The partnership must choose the calendar year because it has no principal partners. e. None of these choices are correct.

a. The partnership can request permission from the IRS to use a January 31 fiscal year if it can establish that is a natural business year. Because the partnership does not have any majority partners and because the principal partners do not all have the same taxable year, the least aggregate deferral rule determines the partnership's "required" taxable year. The partnership may be able to obtain IRS permission to adopt a different taxable year if it can demonstrate to the IRS that it has a substantial business purpose for choosing that year, such as having a "natural business year." The partnership can also make an election under § 444 (not a choice in this problem).

Manuel contributed property to the newly formed HOME Partnership. The property had a $100,000 adjusted basis to Manuel and a $160,000 fair market value on the contribution date. The property was also encumbered by a $120,000 nonrecourse debt, which was transferred to the partnership on that date. Another partner, Olivia, shares 30 percent of the partnership income, gain, loss, deduction, and credit. Under IRS Regulations, Olivia's share of the nonrecourse debt for basis purposes is: a. $20,000. b. $30,000. c. $120,000. d. $36,000. e. $100,000.

b. $30,000. The § 704(c) portion of the debt must first be allocated to the contributing partner, Manuel. The § 704(c) portion of the nonrecourse debt that is allocated to Manuel under this rule is $20,000 ($120,000 - $100,000 basis). The rest of the nonrecourse debt is allocated in the manner that the partners share in the deductions that relate to the debt. Therefore, Olivia shares in $30,000 ($100,000 × 30%) of the remaining nonrecourse debt.

Erica is a limited partner in the ART Partnership, which is not publicly traded. Her allocable share of ART's passive ordinary losses from a nonrealty activity for the current year is ($70,000). Erica has a $50,000 adjusted basis (outside basis) for her interest in ART (before deduction of any of the passive losses). Her amount "at risk" under § 465 is $40,000 (before deduction of any of the passive losses). She also has $35,000 of passive income from other sources. How much of her ($70,000) allocable loss can Erica deduct on her current year's tax return? a. $50,000. b. $35,000. c. $70,000. d. $40,000. e. None of these choices are correct.

b. $35,000. The $70,000 passive loss must be limited first by Erica's $50,000 outside basis for her partnership interest. The "at risk" rules further limit her deduction to $40,000, the amount she is "at risk" in ART. She can deduct $35,000 of this loss because that is the amount she has of passive income from other sources.

In the current year, the GHI Partnership received revenues of $200,000 and paid the following amounts: $50,000 in rent and utilities and $20,000 as a distribution to partner Hanna. In addition, the partnership earned $6,000 of long-term capital gains during the year. Partner Igor owns a 50 percent interest in the partnership. How much income must Igor report for the tax year? a. $68,000 ordinary income. b. $75,000 ordinary income; $3,000 of long-term capital gains. c. $78,000 ordinary income. d. $65,000 ordinary income; $3,000 of long-term capital gains. e. None of these choices are correct.

b. $75,000 ordinary income; $3,000 of long-term capital gains. The partnership's ordinary income is calculated as follows: Revenues $200,000 Less: rent and utilities (50,000) Ordinary income $150,000 The distribution to Hanna is not deductible. Igor's share of GHI's ordinary income is $75,000. The $6,000 of long-term capital gains is a separately stated item, of which Igor's share is $3,000.

Which of the following is not a correct statement regarding the advantages of the partnership entity form over the subchapter C corporate form? a. A partnership typically has easier administrative and filing requirements than does a C corporation. b. All partners in a limited partnership have no personal liability for entity claims similar to shareholders of a C corporation. c. Partnership income is subject to a single level of taxation; corporate income is double taxed. d. Partnerships may specially allocate income and expenses among the partners, provided the substantial economic effect requirements are met; corporate dividends must be proportionate to shareholdings. e. All of these choices are advantages of partnership taxation.

b. All partners in a limited partnership have no personal liability for entity claims similar to shareholders of a C corporation. General partners in a limited partnership have unlimited liability for partnership debts, whereas shareholders of a corporation have no personal liability (generally) for entity debt. Other types of partnerships (e.g., LPs, LLCs) are used in many situations because they offer less personal liability for the partners.

Tyler and Josie formed a partnership. Tyler received a 25 percent interest in partnership capital and profits in exchange for land with a basis of $40,000 and a fair market value of $60,000. Josie received a 75 percent interest in partnership capital and profits in exchange for $180,000 of cash. Three years after the contribution date, the land contributed by Tyler is sold by the partnership to a third party for $76,000. How much taxable gain will Tyler recognize from the sale? a. $0. b. $36,000. c. $9,000. d. $24,000. e. None of these choices are correct.

d. $24,000. Section 704(c)(1)(A) requires that any precontribution gain must be allocated entirely to Tyler. Therefore, Tyler is allocated the $20,000 precontribution ("built-in") gain and 25 percent ($4,000) of the $16,000 postcontribution gain.

Which of the following statements is always true regarding accounting methods available to a partnership? a. If a partnership has a partner that is a C corporation, it cannot use the cash method. b. If a non-tax-shelter partnership had "average annual gross receipts" of $2 million in all prior years, it can use the cash method. c. If a partnership has a partner that is a personal service corporation, it cannot use the cash method. d. If a partnership is a tax shelter, it can use the cash method of accounting. e. None of these choices are correct.

b. If a non-tax-shelter partnership had "average annual gross receipts" of $2 million in all prior years, it can use the cash method. "If a partnership is a tax shelter, it can use the cash method of accounting" is false because a partnership must use the accrual method if it is considered to be a tax shelter. A partnership must often use the accrual method if it has a partner that is a C corporation ("If a partnership has a partner that is a C corporation, it cannot use the cash method" is false). However, the partnership can use the cash method if (1) the C partner is a personal service corporation ("If a partnership has a partner that is a personal service corporation, it cannot use the cash method" is false), or (2) the partnership has average annual gross receipts of $25 million or less for all prior three-year tax periods ("If a non-tax-shelter partnership had "average annual gross receipts" of $2 million in all prior years, it can use the cash method" is true).

Benji owns a 25 percent interest in a continuing partnership. The partnership distributes a $20,000 year-end cash bonus to all the partners. In a proportionate nonliquidating distribution, the partnership also distributed property (basis of $2,000, fair market value of $3,000) to Benji. Immediately before the distribution, Benji's basis in the partnership interest was $30,000. As a result of the distribution, Benji recognizes: a. Ordinary loss of $8,000. b. No gain or loss. c. Capital loss of $7,000. d. Capital loss of $8,000. e. Ordinary loss of $7,000.

b. No gain or loss.

Juliana receives a proportionate nonliquidating distribution from the JAM Partnership. The distribution consists of $75,000 cash and property with an adjusted basis to the partnership of $20,000 and a fair market value of $25,000. Immediately before the distribution, Juliana's adjusted basis for her partnership interest is $90,000. Juliana's basis in the noncash property received is: a. $0. b. $25,000. c. $15,000. d. $20,000. e. None of these choices are correct.

c. $15,000. Juliana's basis in the partnership interest is first reduced to $15,000 by the $75,000 cash distribution. Because this is a nonliquidating distribution, the basis in the noncash property is the lesser of $15,000 (remaining basis in the partnership interest) or the partnership's $20,000 basis in the property. The basis in the property, therefore, is $15,000, and Juliana's basis in the partnership interest is reduced to $0.

Sally and Roberto formed the RT Partnership four years ago. Because they decided the company needed some expertise in multimedia presentations, they offered Katie a 1/3 interest in partnership capital if she would come to work for the partnership. She will also receive a 25 percent interest in future partnership profits. On July 1 of the current year, the unrestricted partnership capital interest (fair market value of $25,000) was transferred to Katie. How should Katie treat the receipt of the partnership interest in the current year? a. Nontaxable. b. $25,000 long-term capital gain. c. $25,000 ordinary income. d. $25,000 short-term capital gain. e. None of these choices are correct.

c. $25,000 ordinary income. A person who receives an unrestricted partnership capital interest for services rendered recognizes ordinary income when the interest is received. The amount of income recognized is the fair market value of the partnership interest on the date it is received.

Jane contributed property with a basis of $40,000 and a value of $50,000 to the JO Partnership in exchange for a 20 percent interest in partnership capital and profits. During the first year of partnership operations, JO had net taxable income of $30,000 and tax-exempt interest income of $10,000. The partnership distributed $10,000 cash to Jane. Jane's adjusted basis (outside basis) for her partnership interest at year-end is: a. $36,000. b. $70,000. c. $38,000. d. $60,000. e. None of these choices are correct.

c. $38,000. Jane is a 20 percent partner and shares in 20 percent of the partnership's taxable and tax-exempt income, or $8,000. Her basis is reduced by the cash distribution during the year. Jane's ending basis is calculated as follows: $40,000 beginning basis + $8,000 [20% × ($30,000 + $10,000)] - $10,000 distribution.

At the beginning of the tax year, Zack's basis for his partnership interest and his amount at risk in the partnership was $30,000. His share of partnership items for the year consisted of tax-exempt interest income of $2,000 and an ordinary loss of $44,000. He also received a distribution from the partnership of $20,000 cash during the year. For the tax year, Zack will report: a. A nontaxable distribution of $20,000, an ordinary loss of $10,000, and a suspended loss carryforward of $34,000. b. An ordinary loss of $44,000 and a nontaxable distribution of $20,000. c. A nontaxable distribution of $20,000, an ordinary loss of $12,000, and a suspended loss carryforward of $32,000. d. An ordinary loss of $32,000, a suspended loss carryforward of $12,000, and a taxable distribution of $20,000. e. None of these choices are correct.

c. A nontaxable distribution of $20,000, an ordinary loss of $12,000, and a suspended loss carryforward of $32,000. The $20,000 distribution and the $2,000 share of partnership tax-exempt income combine to reduce Zack's basis for his partnership interest to $12,000 ($30,000 + $2,000 - $20,000). Zack will then be allocated the $44,000 partnership loss; $12,000 of which is deductible and $32,000 of which is suspended.

Charlie receives a proportionate nonliquidating distribution when the basis of his partnership interest is $40,000. He received a cash distribution of $45,000 and a property distribution (basis of $10,000 and fair market value of $12,000). How much gain or loss does Charlie recognize; what is his basis in the property he received; and what is his remaining basis in the partnership interest? a. $0 gain or loss; $10,000 basis in property; $5,000 remaining basis b. $17,000 gain; $12,000 basis in property; $0 remaining basis c. $0 gain or loss; $12,000 basis in property; $3,000 remaining basis d. $5,000 gain; $0 basis in property; $0 remaining basis e. $5,000 gain; $0 basis in property; $5,000 remaining basis

d. $5,000 gain; $0 basis in property; $0 remaining basis Charlie's basis is first reduced by the $45,000 cash distribution. As the $45,000 distribution exceeds Charlie's basis by $5,000, a $5,000 gain results and Charlie's basis is reduced to $0. The property distributed takes the lesser of a carryover basis ($10,000) or Charlie's remaining basis in the partnership interest ($0); therefore, Charlie has no basis in the property he received and no remaining basis in the partnership interest.

George sells one parcel of land (basis of $100,000) for its fair market value of $160,000 to a partnership in which he owns a 60 percent capital interest. George held the land for investment purposes. The partnership is in the real estate development business and will build residential housing (for sale to customers) on the land. George will recognize: a. $0 gain or loss. b. $36,000 ordinary income. c. $60,000 capital gain. d. $36,000 capital gain. e. $60,000 ordinary income.

e. $60,000 ordinary income If a partner owns more than a 50 percent interest in a partnership, any property sold to the partnership at a gain results in ordinary income to the selling partner, unless the property was a capital asset both to the partner and the partnership. In this case, the land was a capital asset to George, but it was inventory to the partnership, so the gain is treated as ordinary income. The gain on the sale is $60,000 ($160,000 - $100,000); as this is a sale of George's asset, the entire gain is taxed to him.

Which of the following statements is false regarding accounting methods available to a partnership? a. If a partnership is a tax shelter, it can use the cash method of accounting. b. If a partnership has a partner that is a personal service corporation, it cannot use the cash method. c. If a partnership has a partner that is a C corporation, it cannot use the cash method. d. None of these choices are correct. e. All of these choices are correct.

e. All of these choices are correct. "If a partnership is a tax shelter, it can use the cash method of accounting" is false because a partnership must use the accrual method if it is considered to be a tax shelter. A partnership must often use the accrual method if it has a partner that is a C corporation ("If a partnership has a partner that is a C corporation, it cannot use the cash method" is false). However, the partnership can use the cash method if (1) the C partner is a personal service corporation ("If a partnership has a partner that is a personal service corporation, it cannot use the cash method" is false) or (2) the partnership has average annual gross receipts of $25 million or less for all prior three-year tax periods.

In which of the following independent situations would the transaction most likely be characterized as a disguised sale? a. Partner Carl contributes appreciated property to the NICE Partnership, and three years later NICE distributes $100,000 proportionately to all the partners. b. Terrence contributes appreciated property to the TOM Partnership. Thirty months later, he receives a distribution from the partnership of $15,000 cash. None of the other partners received a distribution. There was no agreement that TOM would make the distribution, and Terrence would have made the contribution whether or not the partnership made the distribution. c. Abigail contributes property with a basis of $20,000 and a fair market value of $50,000 to the HAT Partnership in exchange for a 20 percent interest therein. The partnership agrees to distribute $20,000 to Abigail in 25 months, if partnership cash flows from operations exceed $100,000 at that time. The partnership does not expect to produce operating cash flows of over $100,000 for at least five years. d. All of these choices are correct. e. None of these choices are correct.

e. None of these choices are correct. "Partner Carl contributes appreciated property to the NICE Partnership, and three years later NICE distributes $100,000 proportionately to all the partners" is not a disguised sale, because the partner is merely receiving his share of partnership cash flows. "Abigail contributes property with a basis of $20,000 and a fair market value of $50,000 to the HAT Partnership in exchange for a 20 percent interest therein. The partnership agrees to distribute $20,000 to Abigail in 25 months, if partnership cash flows from operations exceed $100,000 at that time. The partnership does not expect to produce operating cash flows of over $100,000 for at least five years" is not a disguised sale because the distribution is subject to entrepreneurial risk. "Terrence contributes appreciated property to the TOM Partnership. Thirty months later, he receives a distribution from the partnership of $15,000 cash. None of the other partners received a distribution. There was no agreement that TOM would make the distribution, and Terrence would have made the contribution whether or not the partnership made the distribution" is not a disguised sale because the contribution was not contingent on a future distribution being made. In addition, the distribution in "Terrence contributes appreciated property to the TOM Partnership. Thirty months later, he receives a distribution from the partnership of $15,000 cash. None of the other partners received a distribution. There was no agreement that TOM would make the distribution, and Terrence would have made the contribution whether or not the partnership made the distribution". meets the IRS's two-year time frame in which a distribution is generally not presumed to be part of a disguised sale.