Regulation 4 Partnership Interest 1 of 4
Liquidating Distributions Partner can liquidate the partnership interest by
1) Complete withdrawal 2) Sale of Partnership Interest 3) Retirement or death
Tax Losses to the Partner
1) Limited to Basis (CA+%Liability) 2) Carry forward losses (indefinitely) until basis becomes available to take the losses against 3) Partner may be subject to Passive Loss Limitations
Retirement Payments
1) Ordinary income to recipient, 2) Deductions to the partnership.
Formula for Capital Gain/ Loss on Sale of Partnership Interest
= Amount Realized - Adjusted Basis in partnership.
Basis
= Capital Account + Partner's Share of Liabilities
Amount realized
= Cash received + COD (liabilities assumed by partnership) +FMV Property
Retirement or Death of a Partner
= Payment Partnership Interest (Capital Gain) + Other Payments (Taxed as Ordinary income)
Tax Elections are made by the...
Partnership Organizational Expenditure and Start-up Costs: Startup costs excluding costs of raising money are allowed to be deducted up to 5,000 dollars and then the remainder amortized over 180 months. The 5,000 amount is reduced for costs over 50,000. Note, examiners will try and trick you by changing the start date to something other than the beginning of the year. Costs include, fees paid for legal services in drafting agreement, accounting services, and fees paid for partnership fillings.
Partnership Tax Returns
Partnership is not taxed, but it still must file a partnership tax return Form 1065 which includes Schedules K and Schedules K-1.
(LAP) How Property Subject to a Excess Liability effects the Basis Calculation
The liability that decreases the basis below zero is treated as a GAIN (taxable) to the partnership and therefore added back to the partnership basis to make the basis be equal to zero. See example below. Cost of Building = 100,000 Mortgage = 225,000 Partnership 50/50 Partnership Basis CC 0 +PC +100,000 <LAO> <150,000> +S 0 +LAP 0 =Net Basis <50,000> + Boot +50,000 = Basis of Partnership 0
Transactions between Partner and Partnership Partner Not Acting in a Capacity of Partner
The transaction is treated as if the Partnership entered into a transaction with a Third party.
T or F The partner is responsible for their portion of distributive income, even if, the partner is never distributed the share of income.
True.
Where do items appear on the 1065, K or K-1
Type 1065 K K-1 Business Income X <Business Expenses> X <Guaranteed Payments> X X X Net Business Income or Loss X X X Net Active Rental Real Estate or Loss X X Net Passive Rental Real Estate Income or Loss X X Interest Income X X Dividend Income X X Capital Gains and Losses X X Charitable Contributions X X Section 179 expenses X X Investment Interest Expense X X Partner's Health Insurance Premiums X X X Retirement Plan Contributions X X X Tax Credits X X
Forms 1065
US Return of Partnership Income
Hot Assets Exception
Unrealized Receivables, Appreciated Inventory, Recapture Income regarding depreciable assets are treated as Ordinary income
Cancelation of "Cancellation of Debt" Income
When a partnership transfers a capital or profits interest in the partnership to a creditor in satisfaction of partnership debt, the partnership recognizes cancellation of debt income.
Tax consequences of Property subject to (Excess) Liability
When the decrease in the partner's individual liability exceeds the partnerships basis the excess liability is treated as boot. The partner is still liable for a portion of the liability therefore only the portion that the partner is no longer responsible for is counted.
Formation
When the partnership formed the partners contribute money, other property and or services in return for interest. A new partner may also obtain an interest by making a contribution during operations.
T or F you must prorate the partnership income and losses
true
Example. A building with the FMV of 500,000 is contributed by A &B (50/50) is contributed by A at the date the partnership is formed December 31, 20X1. Partner B contributes Cash of 500,000. On January 2, 20X2 the property is sold for 600,000. How is the gain allocated
Cost of a building = 100,000 FMV at the date of contribution = 500,000 Cash Contributed by B 500,000 On the Books Dec. 31 Cash 500,000 Building 500,000 400,000 dollars of Built in Gain by Partner A What happens when you sell? Basis A 100,000 +400,000 +50 = 550,000 Basis B 500,000 +50,000 =550,000 On the books January 2 Cash 1,100,000
Tax consequences of Guaranteed Payments
Deductable by the Partnership and Income to that partner (just the same as a salaried employee who is not a partner). It is included on Line 4 of Schedule K-1 and is subject to self-employment tax.
Stages of a Partnership
Formation, Operation, Taxation, Distribution, Liquidation
GAAP vs. TAX Startup costs
GAAP = expense TAX = 5,000 +180 months amortization of remainder
Sale of Partnership Interest
Gains or Losses are treated as Capital Gains or Losses.
Tax Consequences of Formation
General rule is there is no gain or loss recognized on property (i.e. money and property) contributed to the partnership. However, an Exception exists for Services Rendered, and for property subject to excess liability.
Excess Liability Difference between Partnerships and Companies
In a corporation, the shareholder is no longer liable for any portion of the debt. Therefore the entire liability must be subtracted from the basis. In a partnership, the partner is still liable for a portion of the liability, therefore only the portion that the partner is no longer liable for is considered in the calculation of Boot. Below is an example of the difference between a partnership and a corporation when 100 basis is put in with a liability of 150 and then 250. Entity Basis Liability Liability Put into the Entity Boot Corp 100 150 150 50 Partnership (2 50/50) 100 150 75 None Corp 100 250 250 150 Partnership (2 50/50) 100 250 125 25
Property non-liquidating Distribution Tax Consequences and Basis
In general the property will equal the NBV (not taxed NBV), however, an exception exists when the NBV would decrease the basis to below zero. This is not allowed. Therefore the basis assumes the basis in the property after distributed cash has been deducted from the basis.
Cash/Partnership liability assumed by a partner non-liquidating Distribution Tax Consequences and Basis
In general, cash is not taxed when withdrawn and the cash will always reduce the basis. However, cash will be subject to tax when the cash exceeds the basis. This follows the idea that the excess cash over the basis has not already been taxed and therefore is subject to tax.
Form 1040 and Schedule E
Individual partners report their share of net income or loss
Salaries Not guaranteed
Just another way to distribute partnership profits.
Determination of Partner's Share of Income, Credits and Deductions Taxable Income
Must include all share of partnership income (even if not received) in the tax return for his taxable year within which the taxable year of the partnership ends. Event Tax Consequence Basis Impact Income Taxable Increase Withdrawal Non-taxable Decrease
Partnerships Basis of Contributed Property Valued at
NBV
Non-liquidating Distributions General Rule
Non-liquidating distributions are non-taxable. Like a bank account. The idea is that the partner was already taxed on the income and that taxing the distributions would be a double tax.
When does the partnership terminate?
Operations Cease, 50% or more of partnership interest in both capital and profits is sold or exchanged within any 12 month period., There are less than 2 partners.
Complete Withdrawal
Partner's basis for distributed property is equal to the partner's adjusted basis of the partnership interest minus any cash actually received. Rule is zero out to get out.
Schedule K-1
Partner's share of current year income, deductions, credits and other items
Schedule K
Aggregate or Total of Partner's Distributive Share
In the Tom and Jerry Partnership, Tom decides to sell his partnership interest to Tuffy (Jerry's nephew) with the consent of Jerry. Tom's Adjusted Partnership interest is equal to $100, and the partnership agrees to assume $5 debt (COD). Tuffy buys the partnership interest for $120. What is the amount realized, and Jerry's capital Gain? Now Assume that the $10 dollars worth of gain is due to an Unrealized Receivable. How will this gain be treated?
Amount realized = 120+ 5 = 125 Partnership Basis <100> Capital Gain = 125-100 =25 Unrealized Receivable is a HOT ASSET, therefore $10 dollars of gain due to a hot asset will be taxed as ordinary income.
Schedule M-2
Analysis of Partner's Capital Accounts
Operations of Partnership Partner Basis Formula
B Beginning Capital Account Cash Note this is a capital account valued for tax or adj. book value not FMV Services FMV as discussed in my Partnership Tax class NBV Assets <Liability> A + %All Income Ordinary , Capital, Tax-Free + All Continuing contributions Same as B S <% All Losses> May take loss as a tax deduction Property distributions Reduce Capital account by the NBV of the distributed property cannot go below zero <Withdrawals> E Ending Capital Account (when the account is measured at Tax or NBV not at FMV) +% Recourse Liabilities = Year End Basis
Schedule L
Balance Sheet per Books
Basis of Contributing Partner's Interest
Cash Contributed (CC) + Property Contributed (Adjusted Basis NBV) (PC) <Liabilities assumed by other partners> (LAO) +Services at FMV (taxable to partner) (S) + Liabilities Assumed by the partner from other partners
Effects of Termination
Close old accounts, open new accounts
Guaranteed Payments
Compensation paid to the partner for services rendered. (aka. Not distributions and the partnership is required to pay).
Tom and Jerry have entered into a partnership for a comedy club (after realizing there cat and mouse routine was really funny). They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership distributes $60 dollars worth of cheese. What are the consequences to Jerry's basis and what is Jerry's basis in the cheese
Beginning 100 Additions 0 Subtractions <60> Ending =40 Basis in the cheese = 60
Tom and Jerry have entered into a partnership for a comedy club (after realizing there cat and mouse routine was really funny). They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership distributes $150 dollars. What is the tax consequence to Jerry and what is his basis after the distribution
Beginning 100 Additions 0 Subtractions Cash <150> Ending after cash =<50> Boot/ Gain/ Taxed added to Basis 50 Ending 0 Jerry will be taxed on 50 dollars and his basis will equal zero.
Tom and Jerry have entered into a partnership for a comedy club (after realizing there cat and mouse routine was really funny). They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership distributes $50 dollars and $60 worth of cheese. What are the consequences to Jerry's basis in the partnership and the basis in the cheese
Beginning 100 Additions 0 Subtractions Cash <50> Ending after cash =50 Subtractions Cheese <50> Ending 0 Basis in the Cheese =50
Tom and Jerry have are liquidating (complete withdrawal) of their partnership in running a comedy club after getting into too many life and death fights. They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership makes a liquidating distribution of $60 dollars worth of cheese. What are the consequences to Jerry's basis and what is Jerry's basis in the cheese
Beginning Adjusted basis right before Withdrawal 100 Additions 0 Subtractions <100> Ending =0 Basis in the cheese = 100, Note Jerry will NOT have a loss of 40 since the basis of the cheese because the Cheese is not cash, receivable or inventory.
Tom and Jerry have are liquidating (complete withdrawal) of their partnership in running a comedy club after getting into too many life and death fights. They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership makes a liquidating distribution of $150. What are the consequences to Jerry's and Jerry's Partnership basis
Beginning Adjusted basis right before Withdrawal 100 Additions 0 Subtractions <150> Ending basis after Cash =<50> Additions Gains/ Taxable Boot +50 Ending Basis =0 Jerry will have a 50 dollar taxable gain on the liquidating distribution. His ending basis =0.
Tom and Jerry have are liquidating (complete withdrawal) of their partnership in running a comedy club after getting into too many life and death fights. They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership makes a liquidating distribution of $50 dollars and $60 dollars worth of cheese. What are the tax consequences to Jerry, Jerry's ending basis and what is Jerry's basis in the cheese
Beginning Adjusted basis right before Withdrawal 100 Additions 0 Subtractions cash <50> Ending after Cash =50 Subtractions of Cheese <50> Ending after Cash 0 Taxed on Distribution = 0, Jerry's Basis =0,Basis in the cheese = 50, No loss carry over
Tom and Jerry have are liquidating (complete withdrawal) of their partnership in running a comedy club after getting into too many life and death fights. They are 50/ 50 partners. Jerry has a basis of $100 dollars. The Partnership makes a liquidating distribution of $60 dollars. What are the consequences to Jerry's basis and what is Jerry's basis in the partnership
Beginning Adjusted basis right before Withdrawal 100 Additions 0 Subtractions of Cash <$60> Subtractions of Loss <40> Ending =0 Jerry is not taxed on the cash, and in-fact can recognize a loss. His ending partnership balance =0.
Special Allocations- Built in Gains and Losses
Built in Gains or Losses at the date of contribution are allocated to the partner who contributed the property. Example. A building with the FMV of 500,000 is contributed by A &B (50/50) is contributed by A at the date the partnership is formed December 31, 20X1. Partner B contributes Cash of 500,000. On January 2, 20X2 the property is sold for 600,000. How is the gain allocated Cost of a building = 100,000 FMV at the date of contribution = 500,000 Cash Contributed by B 500,000 On the Books Dec. 31 Cash 500,000 Building 500,000 400,000 dollars of Built in Gain by Partner A What happens when you sell? Basis A 100,000 +400,000 +50 = 550,000 Basis B 500,000 +50,000 =550,000 On the books January 2 Cash 1,100,000
Accounting Period for Partnership
Calendar year partnership return due April 15th. Fiscal Year, Only allowed if year ends Oc. Nov. Dec.
Holding period for Ordinary income asset (inventory)
Holding period of partnership interest starts on the day contributed.
General rule for items on the K and K-1
If it appears on the K it will also appear on the K-1
Related Party Gains
If the partner controls (>50% interest) then gains are taxed at ordinary income if the property is depreciable or if the property is not a capital asset.
Related Party Limitations Related Party Losses
If the partner controls (>50% interest) then losses are not allowed.
Tax Consequences of Complete Withdrawal (Gains and Losses)
The general rule is that there are no tax consequences. The exception, is when cash exceeds the basis. Losses are not recognized unless the basis of the distribution of money, unrealized receivables, or inventory is less than the partnerships interest.
Syndication Costs
Raising money is non-deductible
Schedule M-1
Reconciliation of Income (Loss) per Books
Holding Period for Contributed Property to a Partnership
Section 1231 Asset or Capital Asset Contributed: then partnership interest has the holding period of the Section 1231 Asset.
Tax Consequences of Services Rendered for a Partnership Interest
Taxed at Ordinary Income, valued at FMV.
Basis consequences to withdrawals
The distributions will reduce the basis.
Differences between Non-liquidating distribution and Liquidating Distribution
Withdrawal Basis Used Stopping Point Nonliquidating NBV of Asset Stop at zero Liquidating Partnership interest Must Zero Out to Get Out
