PSHIPs Midterm

*why* be a pship?

*** 1) flexibility of allocating items of gain & loss -- as long as you have *substantial economic effect* -- flexibility with respect to *timing* and *character* 2) single layer of taxation -- vs. double taxation of a corp. -- partners are taxed ONCE on the pship's earnings, so if a distribution is made to them later, they are NOT taxed again (bc they have basis from the previously taxed capital) -- you can have income without cash distribution! this is the FT

Ch 1 Blue Book: #2 A and B have the cash but C has the talent. This is a start up.

*C-corp benefits* -- you can easily transfer ownership -- if A and B aren't looking to invest long-term, then this is a benefit -- they can cash out and get their money > walk away easily *pship benefits* -- start ups often lose money for years -- these losses can pass through to the partners -- this means they pay less in taxes on their individual 1040 tax returns (baring complications we will learn about later) -- this is advantageous because it provides some cash flow (tax benefits) early on What about legal liability? -- What if C is a hacker and really uses the business as a cover to hack into the FBI databases and sell the information to Vlad Putin? -- A and B wouldn't like that -- A C-corp limits their losses from C's unsavory behaviors. But an LLC can also provide this benefit.

biz taxation "models"

*aggregate approach* -- disregard the entity (corporations are simply a "concept") (just 2+ friends doing biz together) -- everything is coordinated at the owner-level ❌ EX: distributions are NOT taxable events b/c income flows through ❌ EX: pships are not taxed at entity-level ❌ EX: partners might be taxed at different rates *entity approach* -- the entity is distinct from the owners (C-Corp) -- tax is calculated/paid by the entity -- distributions are ALSO taxable to owners -- mostly exist to avoid administrative nightmare! ❌ EX: pship files a 1065 (adopt a method of accounting, decide on a taxable year, report taxable income) ❌ EX: pship must make 1031 or 1033 elections (not the partners) ❌ EX: pship has basis in each of its assets ❌ EX: character of pship income is determined @ pship level ❌ EX: pship decided on depreciation method/whether to use installment method *hybrid* -- this is how pships are actually taxed ❌ EX: *rule of thumb*- follow the aggregate approach for pships ❌ EX: *exception*- use entity approach to prevent tax avoidance ❌❌❌ HOW IT WORKS: -- income is characterized at the pship level -- previously characterized income flows through to partners based on how it it is allocated (Ch 5) [*note*: character generally remains the same > operating inc. is taxed @ partners' ordinary rates; capital gain income is taxed @ partners' preferential rates] -- FT income affects partners uniquely

Sec. 723 definition of *inside basis*

*inside basis = pship's basis in all of its assets* = AB of partners' contributed assets -- no gain recog. > no tax > SO no change in basis!

*Sec. 704(c)(1)* pre-contribution gains

*pre-contribution gains* are *allocated to the CONTRIBUTING partner* general rule: -- income, gain, loss, and deduction with respect to property contributed to the partnership by a partner shall be *shared among the partners* -- so as to take account of the variation between *AB property* and *FMV property @ contribution* *built-in gain* = BV asset - AB asset *BV asset* = FMV @ contribution (historical cost) 2 calculations: ⭐️*tax gain* = FMV @ dist. - AB asset ⭐️*book gain* = FMV @ dist. - FMV @ cont. ⭐️ tax gain - book GAIN (if loss, count as 0) = built-in gain allocated to contributing partner !! *recapture attributable to depreciation taken by contributing partner would be allocated to him* exception: 🔵IGNORE FOR NOW: if contributed property is distributed by pship (directly or indirectly) *within 7️⃣years of contribution* -- *ONLY contributing partner recognizes BUILT-IN gain or loss* (FMV property @ CONTRIBUTION - AB property) -- *character of G/L* = character that would have resulted if pship sold the property -- *outside basis* must be adjusted to reflect recognized gain ↑ -- *inside* must be adjusted to reflect recognized gain ↑ -- ⭐️*any excess gain over the built-in gain is SHARED among partners in whichever way they like* *if property distributed has a BUILT-IN LOSS* -- built-in loss = AB prop. - FMV prop. @ contribution -- taken into account ONLY in determining the amount of items allocated to the contributing partner -- ^ in determining the amount of items allocated to other partners, the *basis of the contributed property in the hands of the pship shall be treated as being equal to its FMV @ contribution* 🔵what is the purpose of this? Sec. 704(d): loss limitation -- a partner's distributive share of pship loss (including capital loss) shall be allowed only to the extent of the adjusted basis of such partner's interest in the partnership at the end of the pship year in which such loss occurred

remember:

*primary benefit of organizing as a pship* = flexibility in allocations

why adjust the AB of pship int. for tax exempt int.?

*protects TPs from being taxed* -- in the form of SUPPORTING FUTURE DISTRIBUTIONS Assume: 2 partners in a pship own only municipal bonds which afford them $1,000 tax-exempt income -- both start out with AB's of 0 (only gave their know-how) -- if you only increase the capital accounts and not the outside bases by $500 each ... eventually when a distribution is made to the partners, their bases would be reduced below 0 (ie: triggering a gain) -- if there weren't a rule that gives them basis for tax-exempt income, eventually when they are enjoying the cash caused by this income >>> they are hurt by a taxable gain (ie: the gov is no longer achieving its purpose of subsidizing the state) literally all this is doing is *supporting the future distributions* that result from the cash inflow of tax-exempt income

how do we allocate debt basis?

*recourse*: based on *ECONOMIC RISK OF LOSS* -- does not have to = loss sharing ratio *non-recourse*: based on *PROFIT interest* -- does not have to = profit sharing ratio

Section 761(a)

*subtitle A* -- dealing with *income tax* ONLY IRC Sec. 701-761 deals with pship matters "persons" -- NOT a corp. -- NOT a trust -- NOT an estate 761 says a pship is a: --- "syndicate, group, pool, joint venture, or other *unincorporated* org." ---"through, or by means of which any biz, financial operation, or venture is carried on" ---"and which is not a corp., trust, or estate" under regs. the "Secretary" (*ie: the Treasury*) may, at the ELECTION of all the members of an unincorporated org., *exclude such organization* from the application of subchapter K ---- *IF* income of sep. members can be computed w/o computation of pship TI *AND IF* org. is: 1) FOR *investment purposes only* --- NOT for the active conduct of a biz --- just b/c investments are profit-seeking does NOT mean they are carrying on biz 2) FOR the *joint production, extraction, or use of property* --- NOT for the purpose of selling services or property produced or extracted --- "tendency in common" is NOT a pship 3) BY *dealers in securities for a SHORT period for the purpose of underwriting, selling, or distributing a particular issue of securities* --- need to use an intermediary (IPO or SEO situation) SO, if income of sep. members can be calculated and 1/3 of these situations is present > NOT a pship --- we are trying to figure out if a *separate biz entity* has been formed! otherwise, Subchapter K cannot apply --- this election is AT BEST an *insurance policy for those investors who want to be SURE to preserve the right to make individual tax election w respect to their property* *biz entity*: any entity recognized for federal tax purposes --- a joint venture or other contractual agreement may create this --- if participants carry on a trade, biz, financial operation, or venture --- & divide the profits therefrom IRC 761 definition goals well beyond UPA definition of "2 or more persons..." --- common economic relationships might include: lessor/lessee, employer/employee, lender/borrower --- ^ while pship might be rare in these cases, *the issue frequently arises when TPs jointly own and operate operate property*

pship allocations

*tax should follow book* (not GAAP) -- think about it: individuals don't pay taxes on "paper gains," but only "economic gains" that have been realized book income is a *surrogate for economic reality* so, you can allocate however you want, so long as: -- *tax follows book* & -- *book represents economic reality* [book has to be meaningful!] ⭐️ALMOST ALWAYS, allocations have a purpose -- timing variations -- risk profile variations TAKEAWAY: pship tax allocations must prove to have *substantial economic effect* in order to be allowable -- 1) allocations must be SUBSTANTIAL -- 2) allocations must have ECONOMIC EFFECT IN THE ABSENCE OF *substantial economic effect*: -- allocations still must be made > we figure out what you would have done absent nefarious tax motivations

un-recaptured 1250 gain

--a gain from the sale of *real estate* --held by a *non-corporate taxpayer* -- for *>1 yr.* -- in a *trade or biz* or as *rental property* attributable to tax depreciation deducted at ordinary tax rates gain is taxable *up to 25%* -- can only go below! un-recaptured section 1250 gains are ONLY realized when there is a *net Section 1231 gain* -- capital losses on all depreciable assets offset un-recaptured section 1250 gains on real estate -- Therefore, a net capital loss overall reduces the un-recaptured section 1250 gain to zero. "1250 recap." taxed @ ordinary rates = MIN [realized gain, (actual depreciation - SL depr.)] -- as long as the property is being depreciated using a SL method & held over a year, there is no Sec. 1250 recapture un-recap. 1250 gain (depreciation portion of gain) -- *TAXED @ 25%* -- excess gain NOT due to deprecation *TAX @ CAP. RATE* EX: If a property was initially purchased for $150,000, and the owner claims depreciation of $30,000, the adjusted cost basis for the property is considered to be $120,000. If the property is subsequently sold for $185,000, the owner has recognized an overall gain of $65,000 over the adjusted cost basis. Since the property has sold for more than the basis that had been adjusted for depreciation, the unrecaptured section 1250 gains are based on the *difference between the adjusted cost basis and the original purchase price*. This makes the first *$30,000 of the profit subject to the unrecaptured section 1250 gain*, while the remaining *$35,000 is taxed at the regular LTCG*. With that result, $30,000 would be subject to the *higher capital gains tax rate of up to 25%*. The remaining $35,000 would be taxed at the *LTCG rate of 15%*.

*Sec. 721(a)* non-recognition provision for the formation of pships

--partners do NOT *recognize* G/L --when *contributing property* in exchange for *pship interest* 1) "contributing" - NOT a sale 2) "property" - NOT services (ie: GW is property!) 3) "to a pship" 4) "in exchange for pship interest" why? we want businesses to start up! Sec. 721 (b) -- mention

economic effect ❌*ALTERNATE* test

1) & 2) rules under general test + *QIO provision* -- maintain cap. accounts -- liquidate based on + cap. accounts -- QIO provision this test is more commonly applicable in practice b/c of the increase in LLPs & LLCs (remember that limited partners are NOT obliged to restore negative cap. account deficits) ⭐️ 1. *capital accounts* must be *maintained properly* ⭐️ 2. *liquidations* must be made in accordance with *POSITIVE capital accounts* 🔶before the end of the next taxable year, or the next 90 days, whichever is sooner 🔶otherwise some partners will be taking tax deductions, but NOT bearing the loss of such deductions at the time of liquidation -- ie: 1 partner takes $20 of depreciation each year, but @ time of liquidation the BV of asset is split 50/50 ... this is not fair! this partner benefited from deductions during the life of the pship, and then benefits again by getting half of the BV of the asset ⭐️3. an *allocation* CANNOT *CREATE or INCREASE* a capital account deficit *in excess of the partner's deficit makeup obligation, AS ADJUSTED* [$0 + *expected* adjustments] 🔶 *as adjusted*: 🔶🔶🔶 REDUCE (*add b/c negative*) deficit obligation for any future distributions that are *reasonably expected* to be made to that partner IN EXCESS of any *reasonably offsetting allocations* (ie: income allocations*) 🔶🔶🔶 whenever a limited partner's capital account drops below 0, the general partner bears the burden of this loss. if it is known in advance that a distribution will be made in future periods, the limited partner must now suck it up and bear any loss up to the amount of the distribution >>> if a pship plans to make a distribution next year of $10, and also plans to break even, the limited partner is now obliged to ensure that their capital account *never falls below +$10* 🔶🔶🔶 🔵^ these latter allocations are only taken into account to the extent they are expected to occur during or prior to the year of the expected distribution 🔶🔶🔶 🔵^ we can make a special allocation given that we have enough expected income to help us with expected distributions [ie: we expect enough income to offset our dist.] [no adj. necessary!] [but if there ends up being a neg. balance, that's when QIO comes into play] ⭐️4. *QIO* provision must be included in the pship agreement 🔶 protects the integrity of the prior allocations & and pship's capital accounts 🔶 *insurance policy* for when an *UNEXPECTED* deficit capital account occurs (ie: from a distribution), an item of *gross income or gain must be allocated to the p-ner as QUICKLY as possible* [unlike general scenario, where they only increase deficits @ time of liquidation] -- if a loss is going to reduce a capital account below zero, only reduce such capital account UP TO zero [🔵*only this portion of the loss is considered to have economic effect!*] -- allocate remainder of loss to *partner(s) bearing the economic burden of the loss* ---- 🔵if the limited partner's cap. account has already been reduced to 0, allocate remainder to general partner ---- 🔵the limited partner also does NOT have a deficit restoration obligation, so this is another reason not to allocate remainder to the limited partner 🔶 alternative solve: -- add back QIO to partner with deficit -- subtract QIO to *other partner*

debt *Sec. 752*: treatment of certain liabilities

1) *debt in general* -- the focus of this flash card! 2) *debt tied to an asset* -- "encumbered contributions" -- the focus of a later flash card! ⭐️ 752(a)legal fiction INCREASE: --- increase in a partner's *share* of pship debt --- *partner's assumption of pship liabilities* --- = *CONTRIBUTION* of $ by partner to pship ⭐️debt is *"FUTURE amounts of previously taxed capital"* -- ❌ if debt is *paid off* > pship must use it's after-tax capital to do so -- ❌ if pship *walks away* from the debt > pship has a gain, pays tax, & gets previously taxed capital (amount realized = principal amount of debt @ time of sale of debt) ---- *it is NOT necessary for buyer to assume personal liability for the debt to be included in the seller's amount realized* ⭐️ legal fiction: debt treated as *contribution by partner* OR *distribution to partner* ⭐️ partner's get basis for their debt -- *outside basis* ↑ w share of debt 🔵 pship's *inside basis* includes pship liabilities *recourse debt*: SOMEONE bears the risk of loss -- ❌allocate by *loss interest* *non-recourse debt*: NOONE bears the risk of loss -- ❌allocate by *profit interest* -- *NOTE*: profit interest takes into account more factors than "profit is shared 50/50"

Ch 1 Blue Book: #1 is this a pship?

1) 2 people holding land for appreciation -- appreciation implies it is held for investment -- NOT a pship 2) 2 people lease the land to a 3rd person for farming -- simply leasing land to someone does not imply a pship -- basically just another co-owner -- if they lease more stuff to the farmer, say equipment, then it MIGHT be a pship 3) 2 people construct a motel on land and hire a 3rd person to manage the motel -- a motel (hopefully) has a lot of transactions and a lot of different types of transactions -- YES a pship

what is a pship? as per the *Uniform Pship Act*

1) an association of 2 or more persons... 2) to carry on as co-owners of a biz for profit --- "profit-seeking" does NOT necessarily imply there is a business ------ 1) pooled/shared investment: commingling $ for an investment in land held until selling price swings in your favor [NOT a pship until you start selling property together] ------ 2) biz-related actions [YES a pship]

GMT EX 3:

A, B & C are in a pship. A is entitled to *10,000 in GMT* annual for services rendered to the pship in his capacity as a pner. To the extent that ABC does not have sufficient income to make this payment, *B & C agree to bear the burden of that payment equally*. The income before GMT is *6,000 OI*. -- A gets $10,000 OI -- pship incurs an *ordinary loss* of ($4,000) -- B & C share distributive *ordinary loss* of ($4,000) equally

contribution of AR & AP by cash-method TP

AP is not considered debt! -- net against AR on *asset side* of balance sheet if AP were treated as debt: -- contributing partner might have to recognize a gain on certain *ongoing businesses* (decreasing their likelihood of entering into pships) -- future deductions would be shared among partners (unfair to contributing partner) pship must *allocate BOTH AR & AP to contributing partners as they are received & paid, respectively*

PS Ch 5 PPT

Slides 48-54 tough examples!

non-recourse debt

debt for which NO ONE is liable so, *how do we allocate a deduction when NOBODY in the pship has suffered a loss?* the *LENDER* (bank) is the one who bears the economic risk that *the value of the property will not satisfy the loan* b/c NR deductions can NEVER have SEE, *allocations of non-recourse deductions must be allocated in accordance with the partners' interest in the pship* ^ "allocated in a manner reasonably consistent with the allocation of other significant items of income or deductions that have met the SEE test"

"unrecaptured" 1250

does NOT generate ordinary income -- holding period tacks!

encumbered contributions

don't forget! -- allocate RECOURSE debt based on *loss sharing %* (b/c allocated to those partners who bear the "economic risk of loss" associated with those liabilities) -- allocate NON-RECOURSE debt based on *profit sharing %* *REAL G.* = (FMV property contributed + ENTIRE debt contributed) - (AB property + % share of debts contributed by everyone and yourself) *PROMISSORY NOTE TO PAY PSHIP* -- this is NOT debt -- likely will result in a recognized gain by partner giving note -- this is a promise to give cash, the cash has NOT been given yet, so there is no basis 🔵 pship assumes the debt *to the extent that the debt does not exceed the value of the property* *result*: simultaneous ↓&↑ in partner's share of debt -- partner is relieved from debt ↓ -- partner becomes responsible for a *share* of the debt ↑ -- partner's capital account should reflect the *net* contribution that occurs *simultaneously* -- *NET CONT.* [CAPITAL ACCT.] = FMV asset @ cont. - debt assumed by pship -- *contributing partner's outside basis* = AB asset [inside basis] - debt + %debt -- *other partner's outside basis* = AB their property [inside basis] + %debt^ ^outside basis: -- *decreased by entire amount assumed by pship* -- *increased by share of debt allocated to partner* ⭐️ 752(b) legal fiction DECREASE: --- decrease in a partner's *share* of pship debt --- *pship's assumption of partner's debt* (partner's individual liability goes down) --- = *DISTRIBUTION* of $ to partner by pship ⭐️ legal fiction: debt treated as *contribution by partner* & *distributions to partner* ⭐️733 -- cannot reduce *partner's outside basis* below 0 -- *excess recognized as gain* (LTCG or STCG - *depends on how long pship int. has been held*) -- this gain results soley from the sale of pship interest! not the sale of an asset. therefore, this will always be a CAPITAL gain -- the gain attaches itself to overall pship interest because *outside basis* > inside basis by the amount of the gain -- therefore, if partner's sell their interest, they will not be taxed on this gain again! they got basis for it 🔶Assets ❌AB (*inside basis*) ❌Book (*FMV @ contribution*) ⭐️individual partner's get taxed on any gain from sales of these assets 🔶Partner's A/B/DEBT ❌ AB (*outside basis*) -- A = A's inside bases - A's debt + % A debt + % B debt -- B = B's inside bases - B's debt + % B debt + % A debt -- Debt1 = 0 -- Debt2 = 0 ❌ Book (*capital account*) -- A = FMV cont. - debt -- B = FMV cont. -- Debt1 = debt1 -- Debt2 = debt2 ⭐️TIP for computing OB: make a column on side with 1) each member's total debt contributed & 2) debt allocation -- start with each member's inside BASES (might be more than 1 asset) -- subtract total debt contributed from each member (different for each member) -- add back allocation of EVERY debt to each member -- book side will *always* balance -- tax side will be IMBALANCED when partner's basis is reduced to 0 and an excess exists [discrepancy = gain recognized!] 🔵🔵🔵 recourse debt 🔵🔵🔵 -- simple, intuitive example -- debt shared based on *loss interest* -- *result will SOMETIMES be a capital gain on pship interest* 🔵🔵🔵 non-recourse debt 🔵🔵🔵 -- 1) *pre-contribution gain* = NR debt - AB asset [allocate to contributing partner] -- 2) allocate REMAINING debt among partners -- debt shared based on *profit interest*, which is why we look for any pre-contribution gain up-front -- *result will SOMETIMES be a pre-contribution gain* -- ⭐️outside basis = inside basis *+ pre-contribution gain - entire debt* + share of REMAINING debt -- ⭐️if no pre-contribution gain, treat exactly like recourse scenario

*731* extent of recognition of gain or loss on distribution

encumbered contributions: *treat as a sale of a pship interest* -- meaning, a capital asset. gain shall not be recognized to such *PARTNER*, EXCEPT to the extent that any *"money distributed" (partner's debt assumed by pship) exceeds the adjusted basis of such partner's interest in the pship immediately before the distribution* any G/L recognized under this subsection shall be considered as: -- *G/L from the sale or exchange of the partner's pship int.* *gain increases outside basis to 0* *gain does NOT attach itself to any assets* when a partner contributes property subject to a liability in excess of basis, gain can result

1231

net 1231 gain = LTCG -- *treated as ORDINARY to extent that un-recaptured 1231 losses from the past 5 years exist* -- any LTCL can offset ordinary income up to $3,000 net 1231 loss = ordinary loss ⭐️*1231 gain* -- gain recognized on *sale of prop. used in the trade or biz* -- gain recognized on *involuntary conversion* into property or money used in trade or biz OR held as a capital asset for > 1 year in connection with trade or biz or for profit

Chapter 5: *Pship Allocations*

now we begin a series of lectures that ONLY apply to pships -- as opposed to S Corps too

Ch 5 problem 1 c) ii): if NI was not expected in year 3, how would the answer change?

now, the capital account cannot drop below (20) ^ reduced the deficit obligation (added $30)

reg. example assume that in the first partnership taxable year in which the allocation arrangement described in (i) applies, the partnership realizes $450 of tax-exempt interest and $550 of taxable interest and dividends, so that, pursuant to the partnership agreement, I's capital account is credited with $360 (80 percent of the tax-exempt interest), and J's capital account is credited with $640 (20 percent of the tax-exempt interest and 100 percent of the taxable interest and dividends). the allocations of tax-exempt interest and taxable interest and dividends do NOT have substantial economic effect for the reasons stated in (i) will be disregarded and will be reallocated

since under the partnership agreement I will receive 36 percent (360/1,000) and J will receive 64 percent (640/1,000) of the partnership's total investment income in such year... under paragraph (b)(3) of this section the *partnership's tax-exempt interest and taxable interest and dividends each will be reallocated 36 percent to I and 64 percent to J* SAME AS 2ND TO LAST EX ON CH 5 PPT

TOPIC 2: debt *allocations* dealing with TAX columns -- inside basis -- outside basis

remember: partners' OUTSIDE BASES increase with the allocation of debt OB: how the partner determines his G/L if he sells his interest -- *important in determining how much loss he is able to deduct on his 1040* -- 🔵not all losses "flow through" to the 1040 *704(d)* limits losses to the extent of OB [OB cannot drop below 0!] -- by increasing OB for debt, the partners are able to deduct the depreciation (which they do in fact suffer)

novation example

substitution of an old contract for a new one *A assumes full liability for the $100 pship bank debt & bank releases pship from liability* A now gets basis for full amount of debt (contribution, increase in individual debt) -- ↑ A's outside basis by $50 -- ↓ B's outside basis by $50 -- ↓ debt BK amount to 0 -- ↑ A's capital account by $100 this is as if A had borrowed $100 from bank and given the pship the $100 -- treat like a contribution of $100 by A to pship (basis increase, capital account increase) -- ⭐️⭐️⭐️DO NOT FORGET TO INCREASE CAPITAL ACCOUNT! ⭐️⭐️⭐️ *IF PSHIP PAYS OFF THE DEBT SUDDENLY* -- ↓ cash by $100 -- ↓ A's *outside basis & capital account* by $100 [seen a a distribution by pship to partner! individual debt decreased]

variations in RECOURSE debt takeaways: -- recourse debt *honors* INDEMNIFICATOIN -- recourse debt *does NOT honor* guarantees

⭐️IGNORE *personal guarantees of debt* -- the law assumes that all partners will contribute capital when required to do so -- thus, the guarantee is assumed to never occur -- *GUARANTEEING* → "IF" someone else screws up, you will pay for it; this is *conditional* ⭐️*indemnified recourse debt* is given to the partner who indemnifies -- *treat as if the partner gives cash to pship!* (all debt gets allocated to this partner) -- to indemnify means: "I have assumed your debt, so I am on the hook now" -- *ASSUMING* → you're on the hook immediately; this is *unconditional* ----- ⭐️IGNORE *promissory notes by partners to pship* -- disregard in book questions -- these are just IOU's & NOT the debt we are talking about

DEBT ALLOCATIONS: recourse - economic risk of loss

⭐️step 1: *doomsday scenario* ⭐️step 2: allocate step 1: *doomsday scenario* ❌pretend to liquidate all assets (even cash) for $0 -- this loss will flow through to the pship ❌ all debts must be paid today > so whoever has a negative balance, is the one responsible for this debt -- we follow the pship agreement in so far as we are able! -- ^ *meaning*: if no one goes negative, or if both go negative equally > honor pship loss sharing ratio ... if only 1 person goes negative > he gets all of the debt! ⭐️whoever ends up with a NEGATIVE balance & has to contribute > bears the economic risk of loss ⭐️⭐️⭐️*LIMITED PARTNERS cannot be allocated recourse debt basis beyond the amounts they are obliged to contribute in the future* [Why? SEE] ⭐️⭐️⭐️if there is a LP and a GP & QIO provision [*they meet the Alt. test*]: -- LP: OB - doomsday loss = 0 [can only reduce up to 0!] -- GP: OB - remainder of doomsday loss = -# -- GP bears the risk of economic loss!

PIP

⭐️we can't allow an allocation of only US and only foreign. BUT it appears the partners don't want to share equally. Thus... --- the re-allocation would be based on the *ratio of US and foreign* --- there is 52% US income, then A would get 52% US income and 52% foreign income ⭐️the agreement states that income is to be shared equally, up to 50%. it's the characterization (domestic vs foreign) is what complicates things. --- A & B each get 50% of domestic and 50% of foreign ⭐️future income cannot be predicted scenario --- there is NOT strong likelihood here, so this is NOT shifting --- THUS, it is *substantial* and the *allocation will be respected*

substantial

must be able to ALSO demonstrate that a special allocation has *some effect other than tax savings* (ie: must be substantial) -- more subjective *goal of this requirement*: identify those allocations that have little significance except to reduce the government's share of pship operations 2 tests: ❌ 1) *pre-tax* ❌ 2) *after-tax* substantial means: -- NOT a *shifting* allocation -- NOT a *transitory* allocation ^ 2 examples of common situations that do NOT meet the *pre-tax general rule* -- ie: upon allocation, there was no significant change in the *dollar amounts* received by the partners -- both result in a *negligible effect on the net adjustments to the partners' capital accounts* while *significantly reducing taxes*

*706(b)* taxable year LIMITATION

1) if a pship has a *valid biz purpose* for selecting a taxable year, a pship MAY use a *particular* taxable year 2) BUT, in the *absence of a valid biz purpose*, pship *must adopt its required taxable year* (described on this flash card) 3) *Sec. 444 election*: even in the absence of a valid biz purpose, a *pship may elect to elect a taxable year other than the required* -- as long as *chosen year does NOT result in more than 3 months of deferral* - ie: MUST pick *1/3 immediately preceding months* -- *req. pmt each year = interest free deposit in an amount intended to approximate the taxes that are deferred* [redetermined each yr.] [to offset the benefits of the deferral] ❌❌❌ *pship's required taxable year* ⭐️determined as though pship were a TP ⭐️ taxable year determined by *reference to partners* ... EXCEPT as provided in subparagraph C, *pship's taxable year MUST align with 1/3* ❌ *majority interest* taxable year -- means: taxable year (*if any*)(on 1/365 of the year) which was the SAME for... -- *1 or more partners* having an *aggregate interest in pship profits AND capital > 50%* 🔶 necessary: same YE, *1 or more partners own aggregate > 50%* -- 🔵capital interest = capital + profits -- 🔵profit interest = only profits ❌ if NO majority interest: the taxable year of *ALL principal partners* -- means: partners having *>= 5% interest in profits OR capital* 🔶 necessary: same YE, *ALL >=5%* -- they must ALL have same YE! ❌ if NO majority interest / NO principal partners: the *calendar year* [unless the Secretary by regs. prescribes another period] -- means: *use the year which gives the LEAST AGGREGATE DEFERRAL* -- next flashcard! pship taxable year options: 1) majority interest 2) all principal partners 3) LAD year

to further clarify, a pship is NOT:

1) tendency in common -- jointly held assets does NOT imply pship -- must actively conduct biz 2) expense sharing -- 2 biz can share equip & NOT be in a pship -- EX: doctors & lawyers normally share office space but don't commingle practices *2 features which distinguish an entity form co-ownership* -- biz activity -- sharing of profits

Daryl Dixon contributes his bow to Walking Dead Pship (AB = 20; FMV = 100). Rick Grimes contributes his revolver (AB = 55; FMV = 100).

Although they = partners for purposes for capital, the Walking Dead realizes that a gun is easier to use but prone to running out of bullets. The *duration* & *risk aspects* vary between assets -- all else = we might want the revolver, but once the bullets are gone they are gone -- the arrow that the bow shoots out can be used over and over bow has more future value! -- profit generating capacity INCREASES over time if in earlier years Dixon gets 50% of the income generated by the pship instead of say 25%, this sucks for him! -- he contributed an asset that in reality isn't generating 50% of the pship's profits, so he is paying more tax in earlier years -- this does not = the actual economic effect that is taking place throughout the pship for the 25% taxable income to be allocated to Daryl, and have *substantial economic effect*, Daryl's *liquidation value* of his interest must increase by 25 -- tax must follow book! increase his capital and book accounts by 25 sure it might be administratively easier to split everything 50/50, but the partners ultimate LOSE because of the underlying value of the assets contributed NOTE: if this was an *S Corp.* profits/losses would HAVE to be split based on % ownership

beware! cont... another example

Dwight & Jim both buy a warehouse and rent it to Vance Refrigeration. -- Ryan Howard accidentally burns down the building. Dwight & Jim get the insurance proceeds and acquire *2, separate properties individually*. ❌ SOLUTION: -- the *pship* needed to have *elected Sec. 1033* & needed to have *made the necessary reinvestment* -- there WILL be a taxable gain to Dwight & Jim if they are unaware of the pship & make the 1033 election themselves -- why? bc the ENTITY did not make this election/make the reinvestment. so the gain will FT from the entity to the partners. ❌ 1033 exchange: realized gain from insurance proceeds from property loss due to casualty, theft, or condemnation -- may be deferred *if property damaged is converted into property similar or related in service or use* ❌ if this was NOT a pship, Dwight & Jim would have each qualified for 1033! -- he and Jim would have simply been "co-owners" of the warehouse, and therefore own the WAREHOUSE

beware! being in a pship for tax purposes, but *not realizing it* > adverse consequences while you do not need to file as a pship for state purposes, you are *still a pship* for tax purposes

Dwight & Jim own a beet farming *pship* 50/50 that produces & sells beets. -- they are *using* the land Dwight wants out, so he sells his 50% *ownership interest* in the beet farm to Oscar for Oscar's land. Dwight *thinks* this is a 1031 transaction, but it is NOT! -- Dwight *traded PSHIP INTEREST for land* -- Dwight is responsible for any gain resulting from this transaction ❌ SOLUTION: -- bc this is a pship, the 1031 election has to be made by the *entity*, NOT the individual partners ❌ 1031 like-kind exchange ❌ if this was NOT a pship, Dwight would have qualified for 1031! -- he and Jim would have simply been "co-owners" of the land, and therefore own the LAND -- in a pship you own INTEREST (which does not qualify for 1031)

GMT EX 2:

F is entitled to *100 in GMT* annual for services rendered to the pship in his capacity as a pner. In addition, he has a *30% interest in the pship*. The income before GMT is *60 OI*. -- F gets $100 *OI* (no matter what) -- pship incurs a ($40) *ordinary loss* [ 60-100] -- F gets ($12) distributive share of *ordinary loss* [ -40*30%] ⭐️ GMT CAN *PUSH PSHIP INTO A LOSS*

GMT EX:

F is entitled to *100 in GMT* annual for services rendered to the pship in his capacity as a pner. In addition, he has a *30% interest* in the pship. The *income before GMT is 200 LTCG*. -- F gets $100 *OI* @ YE -- pship incurs a *$100 ORDINARY loss* -- F also gets distributive share of ($30) from the pship's *ordinary loss* [ -100*30%] -- F also gets distributive share of $60 from *LTCG* [ 200 *30] -- F gets: ordinary inc = $100 ... ordinary loss = ($30) ... LTCG = $60 ⭐️ CHARACTER MATTERS -- guaranteed payment is an ORDINARY deduction for the pship ... NOT a capital loss; therefore, we do NOT net the numbers together -- pship ends with a $200 LTCG & $100 ordinary loss

*707*: *GMT* - guaranteed payments

GMTs are: ❌ pmts to a partner for services OR the use of capital ❌ to extent *determined without regard to the income of the pship* ⭐️ partner treated as being a *NON-PARTNER* ⭐️ entity-level: *deduction* ---- can push pship from profit to loss ⭐️ partner-level: *ORDINARY income* ---- pretending like it is always ordinary, regardless of whether the pship is involved in biz that generates ordinary income or not ❌but only for the purposes of section 61(a) (relating to gross income) ❌subject to section 263, for purposes of section 162(a) (relating to trade or business expenses) the code has now recognized that partners would also like some fixed component for their income -- idea of *salary* + *bonus* -- fixed returns to a partner for investments of labor/capital sometimes sales are volatile: what if the entity doesn't make the amount of the GMT in a given year? -- ⭐️the partner STILL get a guaranteed payment! -- GMTs are *NOT dependent on future income* *TIMING of recognition* ⭐️PSHIP: deduction governed by the *accounting method of pship* ALONE ⭐️PARTNER: OI includible when it is *allocated* (@ YE), NOT when cash is received ---- only big difference between GMTs & salaries ---- recognize OI when the GMT is *set aside*, NOT when actually received

NOTE

LTCG: *> 1 year* STCG: *<= 1 year*

example: 2 individuals jointly purchase a taxi for each to use 12 hours a day for their own individual profit

NOT a pship why? *lack of joint profit motive*

contribution of a note, with NO mention of assignment to pship

NOT reflected on BS or capital account, *until PSHIP DISPOSES of note or PARTNER PAYS note* no outside basis is awarded for the contribution of your own note that you are ultimately responsible for -- this type of note is *not really a contribution of property*, but a PROMISE (in which the partner has no basis) to make a contribution in the future --- in the future, partner will have to pay the debt --- at this time, the partner will get basis for paying this amount to pship, who then pays the debt --- ↑ cash, ↑ outside basis, ↑ capital account --- alternative: pship disposes of debt --- at this time, the partner is paying the debt that belongs to the partner, which REDUCES the partner's individual debt (this is a distribution) --- ↓ cash, ↓ outside basis, ↓ capital account

QIO example

NOTE that the year 1 & year 2 allocations of depreciation and the unexpectedly low income in year 2 have resulted in A being in a negative capital account position. --- this is unacceptable, as he is not liable to restore negative balances. -- this was never intended and NOT in expectation (had we known everything perfectly, we never would have allowed the depreciation allocation) -- but we did allow it > we can't be paralyzed by the fear of "what if" beyond a reasonable expectation [this is why QIO exists!] under the QIO, A's share of gross income must be increased (and B's share correspondingly decreased) by $300 in order to eliminate A's capital account deficit. DO THE FOLLOWING FOR A & B: (increase A's share of GI, decrease B's share of GI) ❌ GI ❌- deduc. ❌= NI alloc. allocations of income and gain *pursuant to a QIO* are considered to be made in accordance with the partners' interests in the partnership -- the allocation is treated as consisting as a *pro rata portion of each item of income and gain of the partnership* -- IE: gross income = $1,000 // QIO = $100 // gross income is 25% rental & 75% interest ---- 25% of QIO = rental ($25) ---- 75% of QIO = interest ($75)

*Sec. 724* pre-contribution character "character of gain or loss on contributed *unrealized receivables, inventory items, and capital loss property*"

NOTE: if the asset is generated by the pship, 724 irrelevant -- if it is NOT contributed, do not get confused by this! ⭐️Ron Swanson sells carved wooden flutes. They are inventory to him. He is also a pner in Torso Pship, which holds wooden flutes as a capital asset. -- Sales of wooden flutes flow through as capital to Ron Swanson. -- HE DID NOT CONTRIBUTE THESE FLUTES! ⭐️Leslie Knope is super excited to have recently joined Pawnee Pship. She joined *two days ago*. Pawnee Pship sells assets which are long-term capital assets. -- Leslie has *long-term capital flowthrough* [we don't care that she only held the interest for 2 days] -- THE PSHIP DETERMINED THE CHARACTER ❌❌❌ the *pre-contribution character* of property is preserved *most of the time* -- property that is inventory in the hands of a partner might become a capital asset upon contribution to a pship engaged in a different trade of biz (*solution*: treat as inventory to pship for first 5 years, then in year 6 treat as whatever pship using asset for!) -- what did the biz do immediately before contribution? inventory means different things to different people! 1) contributed *unrealized receivables* -- must have been contributed by a partner to pship & unrealized by partner pre-contribution -- ⭐️G/L recognized by pship on disposition = *ORDINARY* (taxable to contributing partner) 2) contributed *inventory items* -- must have been contributed by a partner to pship & an inventory item pre-contribution -- ⭐️G/L recognized by pship on disposition within 5️⃣years of contribution = *ORDINARY* -- after 5️⃣years you ask: what is this item to the PSHIP now? the pship might still characterize it as inventory, but if it doesn't anymore the character might change! 🔵🔵🔵3) contributed *capital LOSS property* -- must have been contributed by a partner to pship & a capital asset pre-contribution -- ⭐️LOSS recognized by pship on disposition within 5️⃣years of contribution = *CAPITAL* but limited to the MIN (capital loss @ CONT. date, capital loss @ DIST. date) -- ⭐️under 704(c), contributing partner recognizes the built-in loss and any excess is split among partners -- 🔵*summary - within 5 years*: any *built-in* loss on a CAPITAL asset *retains its capital characterization* for the first 5 years of pship & is allocated to contributing partner. any excess loss is divided among the partners and characterized with respect to the *pship's use of the asset*. -- 🔵*summary - after 5 years*: any *built-in* loss on a CAPITAL asset is characterized with respect to the *pship's use of the asset* & allocated to contributing partner. any excess loss is divided among the partners and characterized with respect to the *pship's use of the asset*. (ie: ordinary if pship is a securities dealer) ❌ if any property described in subsection (a), (b), or (c) [1,2,3 ^] is *disposed of in a nonrecognition transaction* -- tax treatment which applies to such property under such subsection shall *also apply to any substituted basis property* -- 🔵similar rule shall also apply in the case of a series of non-recognition transactions ^ EXCEPTION: -- does NOT apply to any stock in a C corp. received in an exchange described in Sec. 351 -- Sec. 351: pship dist. property in return for controlling ownership in C corp. stock

economic effect ❌*GENERAL* test

REMEMBER: *capital accounts reflect the equity that each partner has in the venture* -- the balance is = to the amount that she would be entitled to if the pship were to *sell its assets for their BV, pay off its liabilities, & liquidate* tax must follow book (your economic reality) these requirements must be met throughout the entire term of the pship ⭐️ 1. *capital accounts* must be *maintained properly* 🔶 ↑ by FMV contributed less debt & book inc. 🔶 ↓ by FMV distributions less debt & book losses 🔶 if this does NOT happen, we do not know what the economic interest in the pship is ⭐️ 2. *liquidations* must be made in accordance with *POSITIVE capital accounts* 🔶before the end of the next taxable year, or the next 90 days, whichever is sooner 🔶otherwise some partners will be taking tax deductions, but NOT bearing the loss of such deductions at the time of liquidation -- ie: 1 partner takes $20 of depreciation each year, but @ time of liquidation the BV of asset is split 50/50 ... this is not fair! this partner benefited from deductions during the life of the pship, and then benefits again by getting half of the BV of the asset -- ^ the other partner got NO deductions, and then also gets 1/2 of the BV of the asset ⭐️ 3. *UPON liquidation*, partners must *restore deficits* in capital accounts -- unconditional obligation under local law OR pship agreement -- when a partner has a negative capital account upon liquidation, he or she is responsible for paying this amount back to the pship -- since the partner must AT SOME POINT contribute capital to eliminate any deficit, she is in a very real way bearing the burden of these losses & deductions [it's ok to let cap. accts. drop below 0 because partners have an unconditional obligation to eventually restore] 🔶before the end of the next taxable year, or the next 90 days, whichever is sooner [otherwise we could hold the deficit forever > tax avoidance scheme] 🔶if a partner does NOT have to restore a deficit > he walks away OWING $ & NOT suffering any loss b/c he didn't have to pay it back! 🔶 *LIMITED PARTNERS do NOT have any obligation to restore a negative balance* -- EASY TO FORGET

how to solve:

SEE rules continue to apply for years when NR debt <= BV! -- ie: if a partner has no obligation to restore a deficit in his capital account (& there's no mention of QIO), and his capital account goes negative > this allocation is NOT allowed & must allocate based on pship interest in the year NR debt > BV, SEE rules NO LONGER apply! *pship needs to*: --have PMGCB provision --maintain capital accounts --liquidate based on + bal. --NR allocations must be reasonably consistent with allocations of other deductions from same agreement --all other material allocations must be valid* -- NOW the partner's capital account can go negative UP TO the amount of the PMGCB ❌❌❌ the minimum gain rule does *NOT protect a partner* from a negative capital account in excess of the minimum gain ❌❌❌cumulative amount of NR deductions = PMGCB for a given year ⭐️don't forget: *he who gets the deduction, gets the gain* ⭐️year asset is sold: -- FMV = BV (so no gain on sale) -- there is gain on debt discharge! (this is the PMGCB) INCREASE partner's capital account to 0 [now everyone/everything is @ 0]

*partner's* holding period

Sec. 1223(1) -- cash, inventory, & receivables do NOT have holding periods -- partner's holding period in pship interest = *Day 0* - STCG -- 1245 recapture does NOT having a holding period b/c ordinary inc. *split holding periods* - some STCG, some LTCG -- allocated by *relative FMV* -- ⭐️we do NOT split basis (you only have 1 basis in pship) ---- when you say 70% of holding period tacks, that means 70% of the holding period in pship interest is treated as LTCG when sold [retains the holding period of property transferred]

if tax does NOT follow book

crazy things happen IRS says: ⭐️if your capital account goes up > so should your tax capital (you pay taxes) ⭐️if your capital account goes down > you deserve a deduction

Sec. 721 & 722 & 1223(1)

deal with the *PARTNERS* 721(a) - non-recognition of G/L provision for partners when they contribute property in exchange for pship interest 722 - definition of outside basis 1223(1) - partner's holding period *IN PSHIP INTEREST* tacks to extent the partner contributed *non-ordinary, non-cash property* --- *tacks means*: holding period in pship interest = holding period thus far of property exchanged --- *DOES NOT tack mean*: holding period in pship interest = begins upon formation of pship

*703(a)* calculation of *pship taxable income*

^^^ a pship will calculate taxable income the same way as an individual does with the exception of items listed in *702(a)* [sep. stated items] ❌ 703(a) book notes: denies *2 types of deductions* normally permitted to individuals: -- meaning: these are sep. stated! 1) deduc. considered *inappropriate for pships* -- EX: deduc. for *personal exemptions* -- EX: *additional itemized deduc.* 2) deduc. that have *benefits which are (or have been) directly passed through to the partners* in their individual capacities -- EX: certain foreign taxes -- EX: charitable contributions -- EX: NOLs -- EX: depletion of oil & gas wells

example: 2 individuals purchase a taxi and lease it to a 3rd party, sharing rental payments

a pship MIGHT exist primary Q: *are the individuals engaging in activities (with respect to the cab) for the purpose of conducting a biz?* -- depends on whether the co-owners were responsible for, and shared the various expenses of keeping up the cab -- AS OPPOSED TO simply sharing rental payments from a net lease (similar to farm example > just because you are sharing profits does NOT mean you are actively conducting a biz)

pship characterization

absent the 724 rules created to avoid people converting ordinary gains into capital, or capital losses into ordinary... pship DOES characterize (& make elections regarding) most transactions: ⭐️Ron Swanson sells carved wooden flutes. They are inventory to him. He is also a pner in Torso Pship, which holds wooden flutes as a capital asset. -- Sales of wooden flutes flow through as capital to Ron Swanson. ⭐️Leslie Knope is super excited to have recently joined Pawnee Pship. She joined *two days ago*. Pawnee Pship sells assets which are long-term capital assets. -- Leslie has *long-term capital flowthrough* [we don't care that she only held the interest for 2 days] ⭐️Sec. 453 requires partners to report income from installment sale under installment method (payments as received) -- EXCEPT: unless *pship* MAKES ELECTION under 453(d) to opt out -- the partners cannot individually make this decision ❌ *703(b)* says elections are made at ENTITY-LEVEL with 3 exceptions

Sec. 721 & 723 * 1223(2)

deal with the ENTITY itself 721(a): non-recognition of G/L provision for PSHIP when they give interest for property 723: *inside basis = AB pship assets + any recog. gain by contributing partner* 1223(2): *pship's holding period IN PROPERTY is the SAME as the contributing partner's* (carries over for ALL assets) -- continue depreciating depreciable assets -- holding period for inventory/other ordinary income items starts @ 0

substantial ❌*after-tax* "exception" last ditch effort by IRS to prevent tax payers from taking advantage of *TIME VALUE OF MONEY* when determining allocations focus: after-tax effect on partners TRANSITORY is meaningless here because this test takes into consideration PRESENT VALUE

allocations CANNOT lower one partner's tax bill without increasing the other partner's tax bill -- *aggregate tax bill* cannot go down (∑tax bills of A and B cannot ↓) *"if, at the time the allocation becomes part of the pship agreement..."* --- after-tax consequences of *at least 1 partner*, in PV terms, is enhanced --- BUT --- *NO OTHER partner's* after-tax consequences are diminished in PV terms THEN: --- special allocation is NOT allowed & re-allocation must be established in accordance with PIP --- 🔵in making this determination the *value = basis rule* applies ⭐️ allowed to accommodate PV ⭐️ NOTE: the *5 year rule* is NOT relevant to the *after-tax test* ! when an arrangement does not APPEAR to violate the transitory allocation rules because the adjustments to the partners' capital accounts (*pre-tax test*) would differ substantially from what they would have been in the absence of the allocations... the allocations might nevertheless be considered INSUBSTANTIAL under the *after-tax exception*

*704(a)*

allows for the *distributive share of income* to be *based on the pship agreement* -- sometimes it's an easy % -- other times, not so much ⭐️ SO LONG AS tax allocation *reflects the manner in which partners are sharing the economics of a given tax item*, allocations within a pship agreement will be honored -- ^ AKA *safe harbor rule* ⭐️an allocation that does NOT have see may still be sustained if it is *in accordance with the partners' interests in the pship* ❌ note: *an allocation might fail to have SEE, but still be in line with the partners' interest in the pship, so NO re-allocation would be necessary!* ⭐️special rules exist for allocations dealing with *non-recourse debt deductions* & *revaluations* -- so these CANNOT have SEE within the meaning of the regs -- they will be "deemed" to be in accordance with the partners' interests in the pship (& be valid) *if special rules are followed* steps: -- 1) check if pship passes safe harbor & has SEE -- 2) if not, check if allocations are consistent with partners' interest in the pship -- 3) if not, re-allocate in accordance with those interest

NOTE:

always assume *SL, full-year convention* for depreciation

transitory allocation ^ example of a common situation that does NOT meet the *pre-tax general rule* -- ie: upon allocation, there was no significant change in the *dollar amounts* received by the partners -- both result in a *negligible effect on the net adjustments to the partners' capital accounts* while *significantly reducing taxes*

an allocation is considered to be a "transitory" scheme (and therefore NOT substantial) if there is a strong likelihood @ time of pship agreement: -- ❌the *original allocation will be substantially offset by an offsetting allocation in the current or future year (in the partners' CAPITAL ACCOUNTS* (*pre-tax test*) & -- ❌ the total tax liability of the partners will be less than if the allocations were not in effect (*after-tax test*) ⭐️ deals with *allocations that occur OVER 2 OR MORE TAXABLE YEARS* ⭐️exists to stop shifting of tax costs *ACROSS YEARS* ⭐️ an "original allocation" is made in 1 year, and then the economic effects of that allocation are cancelled out in a later year when an "offsetting allocation" is made EXAMPLE: -- A & B form a pship // A has an expiring NOL CF // they agree to allocate 100% of income to A in year 1, and 100% of income to B in year 2 -- *viewing this within a single year*, there is an economic effect -- *viewing this across years*, we realize this is TRANSITORY! -- this year's allocation to A is completely offset by next year's allocation to B > the capital accounts @ the end of Y2 will be identical to what they would have been had the partners simply split the income equally each year -- ^ yet the tax liability of the partners is significantly different with/without the special allocation ⭐️if @ the time the original & offsetting allocations are made part of the pship agreement (usually in the year of original allocation) there is a STRONG likelihood that the original allocation will *not be "largely offset" within 5 years after the original allocation* > --- the economic effect of such allocations is deemed substantial! (NOT transitory) ⭐️⭐️⭐️ transitory allocations are examined over a *FIVE year horizon* ⭐️⭐️⭐️TP's must assume that *on the date the property is sold: FMV = BV* -- there is an assumption that NO future gains will occur when the property is sold -- thus, you can allocate depreciation expenses because there is NO offsetting gain generated ^ reference EX #8, p. 67 -- capital account adjustments for depreciation are made because it is assumed that it represents a REAL decline in the value of a partner's interest (capital accounts are a surrogate for economic reality) -- because of the *value = basis rule*, there CANNOT be a strong likelihood that the gain chargeback provision will offset the original allocation of depreciation within 5 years of this original allocation (b/c it is presumed that each dollar of depreciation reflects a dollar decline in the value of the property) -- THEREFORE, the *economic effect of the allocation of depreciation is SUBSTANTIAL, in spite of the gain chargeback provision*

least aggregate deferral

an approach to determine a partnership's required YE if: -- a *majority of the partners don't have the same YE* &... -- the *principal partners don't have the same YE* ⭐️*if 3 partners with diff. taxable years, which of 3 taxable years has the LAD*: ❌ TY partner 1 ❌ TY partner 2 ❌ TY partner 3 -- taxable year with the LAD *MUST be one of the taxable years of a partner* as the name implies, this approach minimizes the combined tax deferral of the partners 🔶 *aggregate deferral* = ∑ each partner's deferral for a *given taxable year* 🔶 *deferral = (# months deferred)(partner's PROFITS interest)* 🔶 *# months deferred* = partner YE month - pship YE month [if negative, think about it] -- if *positive* = # deferred -- if *negative* = # NOT deferred (subtract from 12 to get deferred) ⭐️*if 3 partners with diff. taxable years:* -- test EACH partner's TY, but calculating LAD per year -- pick lowest ⭐️⭐️⭐️ taxable year with the LAD *MUST be one of the taxable years of a partner* COLUMNS: 🔶 partner 🔶 partner's taxable year 🔶 *taxable year in question* (same all the way down) 🔶 months of deferral [difference btwn 2&3] 🔶 profits interest 🔶 "deferral" [deferral * interest] [ ∑ of all = AGGREGATE DEFERRAL] issue w LAD: *pship composition is NOT static - pship may amend its agreement from time to time* -- solution: in a pship with frequently changing interests, one must decide how often the pship must change its taxable year to conform to the 706(b) rules -- Code says *test validity of pship's taxable year on the 1st day of each year* [if invalid, must be changed] ---- *EXCEPTION*: once a pship is required to change its taxable year b/c of the *majority interest* rule > pship will NOT need to change its taxable year again for a *MINIMUM of 3 years*

best deferral?

choosing pship YE that is 1 month after partners! remember, *deferral = partner YE - pship YE* -- if negative, this is amount NOT deferred -- subtract from 12 to get amount deferred example: partner YE 12/31 ... pship YE 1/31 -- 12-1 = 11 months deferred ⭐️ if expecting losses, would want immediate loss recognition b/c this saves them money on their tax returns -- would likely want YE that coincides with individual YE

exam tip

clarify you are dealing with NR deduction allocations on the exam these to not abide by the SEE tests b/c they will NEVER have SEE

economic effect ❌*ECONOMIC EQUIVALENCE* test

even though a pship may not satisfy the General or Alternate test, it is *still possible for it to come within the safe harbor rules for economic effect fi its allocations are "deemed" to have economic effect* generally occurs because of state laws designed for when GENERAL PSHIPS do not comply with the requirements of the *general test*, but whose practices would produce the same economic results to the partners that would have been generated if they had complied with the requirements designed for when LIMITED PSHIPS do not comply with the requirements of the *alternate test* [ie: don't have QIO], but whose practices would produce the same economic results to the partners that would have been generated if they had complied with the requirements -- honor pship agreement, in so far as we are able (ie: a limited partner's capital account goes negative - what do we do?) -- at which point, give the GENERAL partner any special deduction allocations -- share any gains equally -- give the general partner 100% of losses -- ref. Ch 5 Problem 1 b) it is highly unlikely that a pship that satisfies the *economic equivalence* test would need to rely on SEE safe harbor -- its allocations would seem almost by definition to be consistent with the partners' interests in the pship

primary function of a pship for tax purposes

facilitate the computation of each partners' share of the venture's profit or loss ⭐️ the pship is NOT a taxpayer! (*Sec. 701*)

overriding theme of the rules applicable to pship operations:

flexibility -- trying to ensure that the *tax consequences* track the *economics* of whatever *deal the partners strike*

liabilities

gain may be recognized in a pship formation *if contributing partner sheds a sufficient amount of liabilities*

when allocations fail ALL 3 tests ... *re-allocation based upon PIP* -- "partners' interests in the pship"

generally, the idea is that: ⭐️ partner that bears the loss should get the tax deduction ⭐️ partner that reaps the gain should get the taxable income one way to determine who should get the allocation is to look at capital accounts *with* and *without* the allocation -- keep in mind that 0 is usually a big deal -- if the capital account is below zero, that partner isn't actually bearing the economic loss to determine this, the regs. list some factors: 🔶 *relative contributions* 🔶 *interests in profits & losses* (if different from taxable income and loss) 🔶 *interests in cash flows* (& other non-liquidating distributions) 🔶 *rights to distribution on liquidation* *certain determinations* [from book, not PPT] -- compare the amount that each partner would receive if the pship were liquidated at the end of the CY to the amount he partner would receive if the pship were liquidated on the last day of the PY -- attempting to determine who was actually burdened by, or benefit from, the item -- ^ special rule for when allocations do NOT have economic effect for failure to meet the 3rd req. of the *general test* (deficit restoration) -- ^ special rule only applies if the allocations are deemed to be substantial, too!

when determining required taxable year

if just 1 partner owns > 50% ... USE THEIR TAXABLE YEAR! easy to forget and waste time do all of the LAD work

negative basis

impossible! you cannot take a deduction that reduces you basis below 0

*economic effect* definition

in the event that there is an *economic benefit* or an *economic burden* that corresponds to an allocation, *the partner to whom the allocation is made MUST RECEIVE such economic benefit or burden* MUST pass 1/3 tests: ❌ 1) *general* ❌ 2) *alternate* ❌ 3) *economic equivalence* if you fail all 3, allocations must be made in *accordance with partners' interest in the pship* -- "we honor the pship agreement, in so far as we are able"

*702(a)* separately stated items

income, expenses, gains, losses, credits, and other items that are excluded from a *pship's operating income (loss)* &... --- disclosed to partners in a pship *separately*... --- B/C the *tax effects may be different for each partner* ❌NOTE: *SPECIAL ALLOCATIONS* must also be sep. stated, so the IRS can test them equivalent to *putting a label on a sandwich wrapper* *intuition*: everything that COULD matter to the individual TP needs to be sep. stated --- everything that doesn't > lumped together in *bottom line income (loss)* separately stating items that will uniquely affect individuals: 1 🔶⭐️ ordinary income (loss) -- bottom line income or loss w/o regard to the sep. listed items -- EX: *GI, Sec. 162 deductions, 1245 recap.* 2 ⭐️ net rental real estate income (loss) 3 ⭐️ other rental income (loss) 4 ⭐️ GMTs 5 ⭐️ interest income 6 a) // b) 🔶⭐️ordinary dividends // qual. dividends -- pship has no idea what you are going to do with your dividends ahead of time -- pship does not know what you are going to do > pship just flags -- dividends eligible for DRD > only affects corp. partners -- dividends that constitute *net capital gain* > only affects NON-corp. partners 7 ⭐️ royalties 8 🔶⭐️gains and losses from sales or exchanges of *capital* assets held for *<= 1 YR.* -- EX: if one partner as a net capital loss, they could potentially offset their % of pship capital gain. while the other partner who doesn't have any net capital losses would have to recognize the capital gain -- individuals must go through the netting process on their own (1. net STCG/L ... 2. net LTCG/L ... 3. combine ... 4. if NET CAPITAL LOSS > net against $3,000 OI ... 5. CF excess indefinitely) 9 (a) 🔶⭐️gains and losses from sales or exchanges of *capital* assets held for *> 1 YR.* -- individuals have different preferential rates -- individuals must go through the netting process on their own (1. net STCG/L ... 2. net LTCG/L ... 3. combine ... 4. if NET CAPITAL LOSS > net against $3,000 OI ... 5. CF excess indefinitely) 9 (b) ⭐️🔵 *collectibles [28%] gain (loss) 9 (c) ⭐️ *un-recaptured 1250 gain* 10 🔶⭐️gains and losses from sales or exchanges of *1231* property [trade/biz, involuntary conversion] -- the pship does not make the 1231 hotchpot, the individual partners do -- pship does not know what your hotchpot will ultimately look like > pship just flags as 1231 -- if partner's hotchpot is *POSITIVE* > LTCG -- if partner's hotchpot is *NEGATIVE* > ordinary -- *watch out for any portion that is considered 1245 recap. > belongs to ordinary sep. stated line item* 11 ⭐️*other items of income, gain, loss, deduction, or credit*, to the extent provided by regs. prescribed by the Secretary 12 ⭐️ Sec. 179 deduction --- his screenshot skips 15 ⭐️ credits 16 ⭐️ foreign transactions 17 ⭐️ AMT items 18 🔶⭐️ tax-exempt income & non-deductible expenses 19 ⭐️ distributions ⭐️taxes paid or accrued to *foreign* countries & to *possessions of the US* -- you can only *deduct* OR take *credit* (not both) -- pship does not know what you are going to do > pship just flags 🔶⭐️charitable contributions -- more appropriate for each partner to run the gamut of all of the special rules & limits of Sec. 170 -- combine with other CC ⭐️ NOLs -- these losses will have already been taken into account by partners in the year that the losses were incurred 🔶⭐️ depreciation -- MACRS, but because individual can CHOOSE straight-line or ADS > must be determined @ partner level ⭐️ depletion -- each partner must individually compute his or her depletion deduc. ⭐️*taxable income or loss*, EXCLUSIVE of items requiring separate computation under other paragraphs of this subsection.

how can you tell when there is a pship?

intent of owners -- existence of pship agreement -- filing a 1065 -- *titling property to an ENTITY rather than JOINTLY* [Mike & Jim, LLP v. Mike & Jim] !! NOTE: if 1 of the parties is incorporated = GAME OVER, there is NOT a pship!

*Rev. Rul. 69-180* How do we handle a pship agreement that states: "A is to receive 30% of the pship income BEFORE taking into account any guaranteed amount, but not less than $100"?

it is not uncommon for a service partner to be entitled to a *certain minimum amount* ⭐️ if the distributive share ultimately EXCEEDS the "minimum guarantee": -- *NO part of that share will be treated as GMT* -- *ALL* is *characterized as part of partner's distributive share under 704(b)* ⭐️ if the distributive share is ultimately LESS THAN the "minimum guarantee": -- distributive share is *characterized as part of partner's distributive share under 704(b)* -- *minimum guarantee - distributive share = GMT* [ordinary inc.] *pship effect*: ❌GMT must be deducted from any OI [*TI = OI + CG*] ❌TI - A's distributive share = B's distributive share ❌to calculate the allocation of OI & CG, must determine *effective profit sharing ratio*: 🔶🔶🔶*A's dist. share / TI* 🔶🔶🔶*B's dist. share / TI* ❌multiply each ratio by OI & CG to determine A's & B's allocation of each ❌don't forget A also gets OI from GMT! 🔶🔶🔶 MAX [ min. guarantee, pship earnings*% ] -- % = partner's distributive share -- if min. guarantee > pship earnings*% ... residual = GMT see full PPT examples see full book examples (p. 132-133)

pship is "treated" as a TP whenever doing so *facilitates computation of the partners' shares of income and deduction* ie: the entity cannot simply be disregarded

it would literally SUCK if each partner had to keep his or her own set of book for the enterprise's activities -- nightmare if partners had diff. taxable years, accounting methods, etc. PSHIP MUST: ⭐️ adopt a taxable year ⭐️ choose a method of accounting ⭐️ make certain elections ⭐️ compute its taxable income *in order to file Form 1065* -- pship provides each partner a Form K-1 which informs them of their respective shares of income/deductions incurred @ the pship-level

revaluations

only allowed b/c of contributions and distributions -- partner liquidates -- partner joins limited to those transactions in which the partners have *significant non-tax reasons* for determining the values of their assets, AND the partners have *adverse interests* *book gains* for the difference btwn book basis historical cost & FMV when: ⭐️⭐️ *new partner joins pre-existing pship* -- NOTE: *does NOT occur when partner joins by buying someone else out* ⭐️⭐️ *existing partner contributes $ or property for interest* ⭐️⭐️ *partner liquidates partially OR entirely out of pship* NOT taxable gains (yet), so do NOT touch outside basis! -- all existing built-in gains and losses @ time of re-valuation are recognized for BOOK purposes and allocated to the pners -- since the tax side doesn't recognize anything, book-tax differences occur just like with distributions where FMV > BK, allocate the gain to the partners *allocate gain to partners by increasing BOOK VALUES only!* -- FMV @ cont. -- capital account NOTE: now there is a new "built-in gain" (or gains) -- so when these assets are eventually sold, the partners who were allocated BOOK gains during revaluation, will now incur TAX gains -- this is why outside basis (tax capital) accounts are helpful when compared to their corresponding capital accounts -- the disparity shows who is responsible for any built-in gain at time of sale ----- ----- ----- *"reverse 704(c) allocations"* ⭐️HOW TO SOLVE ⭐️ --- *FMV @ cont.* becomes NEW inside basis --- *FMV @ revaluation* becomes NEW book basis --- partner's *capital accounts* are INCREASED by their share of gain ❌ when the revalued asset is eventually sold, *OG partners* share the "built-in" gain (created @ revaluation) for TAX PURPOSES ONLY (already accounted for in book) possible allocation methods to resolve B2T diff. [diff. methods can be used for each asset!]: -- traditional -- traditional + curative -- remedial *traditional* -- allocate BiGs/BiLs contributing partners first -- allocate cost recovery to non-contributing partners first -- when allocating tax depreciation, the hope is that the non-contributing partner gets a deduction for her full amount of book depreciation -- the *ceiling rule* prevents us from allocating more than the total tax gain or loss -- ^ any excess increase her B2T disparity & is locked in until she sells her pship interest *traditional w curative* -- don't forget to consider CHARACTER when seeing if an allocation is allowed -- ex: you can offset ORDINARY INCOME with the depreciation that was not allowed due the ceiling limitation *remedial* -- calculate tax and book depreciation under special rules -- allocate using traditional -- make any remedial allocations if necessary

*733* basis of distributee partner's interest

outside basis shall be reduced (but not below zero) by— (1) the amount of any money distributed to such partner, and (2) the amount of the basis to such partner of distributed property other than money

pship formation

partner contributions -- *Sec. 1001*: *real gain = amount realized - AB* -- *Sec. 721(a)*: partners *do NOT recognize any G/L* when contributing property in exchange for pship interest

*706(a)* YEAR in which pship income is includible for partner

partner must include her distributive share of pship income *for any taxable year of the pship ending WITHIN or WITH the taxable year of the partner* key date: last day of the *pship's* taxable year -- partner is treated as receiving and paying (cash-method TPs) OR accruing (accural method TPs) her distributive share of the pship's income/deductions -- for the pship's taxable year which has just ended EX: -- a *calendar year* partner in a pship with a *6/30 fiscal year* -- will include in her 2010 income, her share of pship income/deductions for the period of *7/1/2009 - 6/30/2010* -- b/c pship's taxable year ends WITHIN the partner's taxable year ⭐️*opportunity to defer* -- partner with 12/31 year end; pship with 1/31 year end -- pship begins on 2/1/15 -- partner is like OH YEA, i am earning income from 2/1/15-12/31/15, but i *do NOT have to record this income until 12/31/16* (b/c pship taxable year does not end WITHIN partner's taxable year in 2015) ⭐️⭐️⭐️*value of postponement* --- 1 year interest-free loan from government = *tax due on postponed income*

*Sec. 722* definition of *outside basis*

partner's basis in his pship interest *AB interest (outside basis) = money contributed + ∑ AB property contributed + ANY RECOG. GAIN* -- no taxes paid > so NO change in basis!

*705*(a) - basic effects requires that partner's outside basis be updated to reflect the tax results form ops.

partners outside basis = pship's inside basis + distributive share of *taxable income* + distributive share *tax-exempt income* - (not below 0) distributive share of *taxable losses* - (not below 0) distributive share of *non-deductible expenses* - (not below 0) *distributions*

method of accounting

pship's choice is *limited by the identity of its partners* ⭐️ pships are generally PROHIBITED from using the cash method of accounting if they have *C corps as partners* -- ONLY prohibited when *avg. annual gross receipts of the pship for the prior 3 years > $5 million* -- EXCEPT: always applies to *tax shelters* ⭐️ tax shelters -- if pship meets this definition > must use accrual method (regardless of its size)

pship accounting

purpose: financial accounting NOT taxable income/loss to pship -- financial accounting reflects the *economic well-being of the pship & the relationship among its partners* -- very independent from the determination of tax liability to the partners financial accounts of a pship = *surrogate for economic reality* -- super important in evaluating ALL pship trans. 4 columns on balance sheet ⭐️ 2 for AB (tax) ---- how partners share the tax attributes of a pship ⭐️2 for book purposes (NOT GAAP!) ---- book accounts are regulated by the IRS because they are used to determine the validity of tax allocations ---- governed by tax accounting principles *we maintain outside basis (tax capital) accounts to KEEP TRACK of 704(c) allocations* -- outside basis is measured by the AB in property, while the capital account is measured by FMV -- this disparity is highlighted on BS by looking at the book/tax difference in "equity" accounts -- we know which partners need to be allocated any built-in gain by seeing if their TAX CAPITAL is lower than their *capital account* balance -- avoid gain shifting! 🔶Assets ❌Tax Basis (*inside basis*) --- ↓ by *book depr.* each year ❌Book (*FMV @ contribution*) (historical cost adjusted for depr.) [*ASSETS*] --- ↓ by *book depr.* each year ⭐️individual partner's get taxed on any gain from sales of these assets 🔶Partner's A/B/C/D ... Debt [ *Tax=0 (adj. bases directly) // Bk=entire debt (does not affect capital accounts)* ] ❌ Tax Capital (*outside basis*) --- ↓ by *book depr.* each year ❌ Book (*capital account*) [*L+E*] --- ↓ by *book depr.* each year *capital account* -- book value of each partner's capital -- reflects his *equity* in the firm -- amount he would receive if pship liquidated all of its assets for their "BOOK" value, paid off its creditors, & distributed net proceeds to the partners ⭐️↑ FMV contribution @ contribution date -- cash + FMV prop. - debt -- remains at "BV" (historical cost; does not vary w price fluctuations) ⭐️↑ % of partner's stake in income (*distributive share*) -- ops. -- *capital accounts are character blind*: ↑ tax exempt inc. // ↓ non-deduc. exp. // don't discriminate btwn ord. & cap. inc./losses ⭐️↓ % of losses @ FMV -- ops. -- *capital accounts are character blind*: ↑ tax exempt inc. // ↓ non-deduc. exp. // don't discriminate btwn ord. & cap. inc. ⭐️↓ % of FMV distributions @ distribution -- cash dist. + FMV prop. dist. - debt tied to prop. [*referring to debt that is being taken over! if pship is holding onto debt still, only deduct FMV prop.*] -- *FMV is NOT BV* -- 🔵IMPORTANT: *must recognize BOOK gains/losses when distributing appreciated/depreciated property* [↑(↓) capital account for gains (losses)] -- 🔵IMPORTANT: *^ does NOT mean your recognize gains/losses for tax ... we are talking about BOOK!* ⭐️*not affected by liabilities* (liabilities aren't equity!) -- adjustments to capital accounts for contributed & distributed property are made NET of liabilities *capital accounts are CHARACTER blind* -- ↑ for tax-exempt income -- ↓ for non-deductible expenses -- don't discriminate between ordinary & capital income/losses things to keep in mind: -- how balance sheet is affected by 721 transactions -- how holding period tacks in 721 transactions -- *general theme in summary problem*: non-recognition ❌ characterization matters! -- 1245 recapture = ordinary income -- 1250 "unrecapture" = does NOT generate ordinary income

substantial ❌*pre-tax* "general rule" focus: pre-tax effect on capital accounts SHIFTING & TRANSITORY = violations of general rule

reasonable possibility that an allocation will substantially affect the dollar amounts received by partners *absent tax considerations* if the only effect of an allocation is to reduce taxes *without substantially affecting the partners' pre-tax distributive shares* > the economic effect is NOT substantial

summary problem: why is the amount realized equal for each of the partners?

reflects an = contribution in order to obtain an = division of future profits this is typical, BUT not always necessary

contribution of *depreciable* property complication: 1245 recapture

tangible personal property and intangible property subject to cost recovery deductions ⭐️in the year of contribution, the contributing partner & pship must share that year's cost recovery deduction ⭐️pship steps into shoes of contributing partner > AB carries over; depreciation method/recovery period carries over -- why? no double dipping with depreciation! year 1 is usually the highest amount of depreciation, so IRS is like "no way you get to start on year 1 and take a huge deduction for a 2nd time" *recog. gain = MIN (AD, real gain)* will contribution trigger recapture of depreciation? *1245(b)(3)* -- NO, not at contribution -- *the property remains subject to recapture upon a later disposition by the pship* -- *the pship's amount of recapture INCLUDES the depreciation taken by the contributing partner* *character: ordinary* -- any 1245 gain that WOULD HAVE BEEN recog. = ordinary inc. > no holding period! (*Day 0*) -- *FMV of 1245 prop. - 1245 recog. gain = 1231* > holding period tacks!

types of interest

tax consequences of a *service interest* VARY by the *type of interest granted* ⭐️CAPITAL -- you get a cut of *future profits & underlying assets* -- the person getting a capital interest *gets an allocation of assets into their CAPITAL ACCT.* ⭐️PROFITS -- you get a cut of *future profits* [NO underlying assets!] -- the person getting a profits interest *starts out with a CAPITAL ACCT. BAL = 0*

when a pship liquidates...

the FMV of asset sold - any debt tied to asset = recognized gain (loss) by the pship

limited deficit restoration agreement

the critical point is usually ZERO for meeting the *Alternate test* or the *Economic Equivalence test* if there is a *limited deficit restoration agreement*, the capital account can go negative UP TO THAT POINT -- it just "moves the chain" a little, the same rules still apply ⭐️ rev. rul. example ⭐️ the amount of money that the partner would be *required* to contribute to the pship to satisfy pship liabilities if all of the pship property were sold for the amount of the pship's book basis in the property if there is a *limited deficit restoration* clause, the pship may still qualify for economic effect under the *alternate OR economic equivalence tests* -- the *general test* provides the need for UNCONDITIONAL deficit restoration *alternate test* requires QIO in lieu of an unconditional deficit restoration obligation -- allocations will have economic effect to the extent that they do NOT create a deficit capital account for any partner (in excess of any deficit restoration obligation of that partner) [*as of the end of the pship taxable year to which the allocation relates*] if a partner's limited restoration obligation = to the extent that the pship has any liabilities left to pay after liquidation, *at the end of each year this obligation is =:* ❌ PSHIP RECOURSE LIAB. - VALUE OF PSHIP ASSETS (value=basis rule applies!) ❌ if they are = to one another, this partner has no obligation to restore a negative balance in her capital account ... if this partner is also the one that is supposed to get allocated depreciation, but doing so in this year would force her capital account to drop below zero, the depreciation should be allocated in accordance with the pship agreement instead ... eventually in a subsequent year, the partner who was initially going to get the depreciation can get it again, as long as it does not exceed her deficit restoration agreement

the pship incurs $20 non-deductible & non-capitalized expenditure: "key man" annually renewable term life insurance policies on lives of partners, of which the pship is the owner and beneficiary -- non-deductible b/c eventually will receive tax-exempt income

the premium is gone, and purchases no asset to replace it on the balance sheet -- 🔵what does this mean? therefore, the partners' capital accounts MUST be charged ⭐️⭐️⭐️*IF* the policy were *ordinary life*, or some other type of policy having an *investment feature*: --- the charge would be *limited to* the *excess of the premium over the increase in cash surrender (or other investment value)* [which would be reflected on the asset side of the balance sheet] -- 🔵WHY?

taking a step back

these regs were NOT intended to prevent taxpayers from forming a pship & allocating income and deductions in a way they deem appropriate so long as the allocations are not simply a tax play ⭐️ read literally, the *transitory allocation* rule & the *after-tax rule* present a SERIOUS problem -- sometimes they invalidate many allocations that should be respected -- sometimes special allocations do not have any net effect on partners' capital accounts AND reduce their total tax liability ... so the regs presume these allocations are insubstantial -- it is important to remember that *the Treasury was concerned with allocations made by a pship with a stable, predictable income stream that presents little risk of not playing out as expected, solely to save taxes* ❌sometimes allocations *commercially motivated* (super common) b/c start-ups expect losses early on and don't know exactly when/if these profits will reverse out -- early expected losses are allocated to those partners that actually invest their capital (and therefore bear the loss if the venture fails) -- allocating income first to these partners enables them to recoup their capital if the venture just breaks even ❌these allocations are considered SUBSTANTIAL in the event that they reverse out -- the fact that the venture ends up being successful and saving taxes SHOULD NOT *undermine the allocations*

shifting allocation ^ example of a common situation that does NOT meet the *pre-tax general rule* -- ie: upon allocation, there was no significant change in the *dollar amounts* received by the partners -- both result in a *negligible effect on the net adjustments to the partners' capital accounts* while *significantly reducing taxes*

think *character* -- primarily deals with *allocating the character of incomes* an allocation is considered to be a "shifting" scheme (and therefore NOT substantial) if *in a given year* there is a strong likelihood that @ time of allocation: -- ❌the capital accounts will not vary substantially with and without the allocation (*pre-tax test*) & -- ❌the total tax liability of the partners (taking into account their individual circumstances) will be less than if the allocations were not in effect (*after-tax test*) ⭐️deals with *1 or more allocations that occur WITHIN 1 TAXABLE YEAR* ⭐️ exists to stop *shifting tax costs BTWN PARTNERS* in the *same year* ⭐️ if both ❌'s are met, regs. presume that @ the time of allocation, it likely that they would occur EXAMPLE: -- 2 general partners // A is in 40% bracket, B is in 0% bracket // pship calls for sharing income 50/50 // pship has $100 of tax-exempt income & $100 of taxable income // A is allocated all of the tax-exempt income, while B is allocated all of the taxable income -- under the *shifting tax consequences rule*, the economic effect of these allocations is NOT substantial -- strong likelihood that both ❌'s are met -- *reallocate based on PIP*: A & B should each get 50% of tax-exempt income and 50% of taxable income note: capital accounts aren't changing! but the over tax liability of the partners is! EXAMPLE: -- DO NOT FORGET ABOUT *3K offset limit*: capital losses can offset OI up to $3,000 -- will likely have to compare NET TAXABLE INCOME *with* and *without* special allocation

receivables for services rendered to someone else

this is considered property! different than services rendered to the pship

TOPIC 1: NR *deductions* dealing with BK columns -- BV asset -- Capital Account

those deductions that arise b/c of NR debt -- ie: depreciation on a property with NR debt tied to it when a property subject to NR debt is disposed of in a taxable transaction, *the full amount of debt must be included in the amount realized, regardless of the value of the property @ such time* -- the debt was treated as "true debt" when it was incurred (generating full basis credit in the acquired property, even though the proceeds are tax-free) -- SO, the debt must be treated as "true debt when it is discharged" ⭐️when selling an asset, forgiven debt = amount realized ⭐️under the value=basis rule, we assume an asset's FMV = BV (always!) ⭐️PSHIP MINIMUM GAIN CHARGEBACK: *NR Debt > BK Value Property* -- debtor must include in income an amount = to difference, to offset the inclusion of deductions previously allowed by the debtor -- NR deduction allocations (even into negative capital accounts) are *permitted to the extent of this minimum gain* -- immediately allocates a *reduction in minimum gain* to the *partner who received the NR deductions* [this "reduction in minimum gain" occurs *when the asset it sold!*] -- HE WHO GETS THE DEDUCTION, GETS THE GAIN! -- ensures there is no "free lunch" allocations; b/c the deductions end up being reversed and taxed ❌ 1) Prongs 1 and 2 of the 3 Prongs hold for all other allocations -- Maintain capital accounts -- Liquidate based on + cap accounts ❌ 2) NR allocations are *reasonably consistent* with allocations of other deductions from the same pship agreement ❌ 3) Must have a *pship minimum gain chargeback* -- This is critical -- These negatives will not bother me as much anymore because we make everything fair and equal ❌ 4) All other *material allocations* and *capital account adjustments* are VALID

Check the Box Regs - *301.7701-1*

used to be complicated to determine if an entity was a pship now: -- any *unincorporated* entity with *2 or more partners* can choose to be a pship EX: LLC -- for state purposes, an LLC is not a pship -- LLCs have to *elect* to be treated as either *pships* or *s-corps* for tax purposes -- if 1 person > *DRE* book says: -- once characterized as an entity, the enterprise will be taxed as a pship (unless it elects to be taxed as a corp.) & subject to the reporting and filing req. imposed by Subchapter K

biz purpose test for adoption of non-required tax year

what does NOT qualify: ❌admin. convenience to partners or accountants ❌desire to maximize deferral for partners ❌compliance with tax laws what DOES qualify: ⭐️must conform to the pship's *natural biz year* ---- pship operating a ski resort that ceases biz in April might succeed in applying for an April/May YE *biz purpose is determined as follows:* ⭐️Over the past *3 years, 25% or more of gross receipts* were realized in the *ending 2 months of the year* [notion is: you want to end your FY on a high note] [always looking at a PAIR of months] ⭐️*Facts & Circumstances* ↓ 🔶🔶 *regulatory* or accounting purposes --- utilities are highly regulated, so if this process closes in February, it makes sense that the FY ends @ this time too 🔶🔶 seasonal *hiring* patterns 🔶🔶 *admin. purposes* such as retirement, salary raises, etc. --- if I ONLY give bonuses and promotions in March, might make sense to rend the year around this time 🔶🔶 *compliance w tax laws is NOT a valid reason*

in the case of a distribution (not a sale) of that has appreciated in value, any *gain* affects only the BOOK accounts, while the *distribution* affects both TAX & BOOK accounts if this property were "contributed property" & there was a built-in gain on a property that is being distributed, would the built-in portion of the gain require any special treatment? implications if distributed to partner that contributed it? -- 🔵*IRC doesn't mention...* implications if distributed to another partner? -- 🔵*IRC says treat like you would a sale...*

🔵WHAT MB SAID: STILL CONFUSED ... NO. -- built-in gain is ignored gain = FMV - BV adjust BOOK accounts for gain adjust TAX & BOOK accounts for dist. -- reduce *outside basis* by *AB* -- reduce *capital account* by *FMV* ⭐️built-in gain only EVER touches (adjusts) the tax capital account (*outside basis*) --- the built-in gain in this situation will be dealt with during liquidation [haven't learned this yet]

updating balance sheet

🔶Assets ❌AB (*inside basis*) ❌Book (*FMV @ contribution*) ⭐️individual partner's get taxed on any gain from sales of these assets 🔶Partner's A/B/DEBT ❌ AB (*outside basis*) ❌ Book (*capital account*) 1) leasing land #1 for $15 (generates inc.) -- ↑ *outside bases & capital accounts* [allocate to all partners] 2) sell security for $50 (no G/L!) -- ↑ cash -- ↓ security's *inside basis & FMV @ cont.* 3) borrow $300 -- ↑ cash -- ↑ *outside bases ONLY* [allocate $100 to each] [debt never affects capital accounts] -- ↑ (create) *debt BK account* 4) purchase land #2 for $330 -- ↓ cash by $330 -- ↑ (create) land #2's *inside basis & FMV @ cont.* -- *do NOT allocate to outside bases or capital accounts* (simply changing the composition of assets) 5) distribute $20 to each partner -- ↓ cash [$60] -- ↓ *outside bases & capital accounts* 6) sell land #1 for $65 (AB = 40, FMV @ cont. = 50) -- ↑ cash -- ↓ land #1's *inside basis & FMV @ cont.* -- ⭐️allocate $10 built-in gain to contributing partner (↑ *outside basis* ONLY - tax purposes!) ⭐️ -- allocate $15 residual gain among the 3 partners [$5 each] (↑ *outside bases & capital accounts*) 7) when land #2's value increases to $420, D joins by bringing $70 cash for 25% stake [BS is revalued!] -- ↑ cash -- ↑ land #2's *FMV @ cont.* to $420 -- ↑ *capital accounts* [$30 x3 = $90 gain] -- (create) *D's outside basis & capital account* -- ↑ *D's outside basis* [$70 contribution + $75 share of debt = $145] -- ↑ *D's capital account* [$70] -- ↓ *A,B,C's outside basis* [$25 - their share of debt decreased] 8) pship makes a $10 charitable contribution -- ↓ cash -- ↓ * outside bases & capital accounts* ($3.33 each) -- essentially a distribution to the partners 9) distributing stock that has appreciated by $60 to all 3 partners (BV = $100, FMV = $160) -- ↑ stock's FMV @ cont. to $160 -- ↑ *capital accounts* ($20 each) [to account for BOOK gain!] -- ↓ (remove) stock's *inside basis [$100] & FMV @ cont. [$160]* -- ↓ *outside bases* by *BV* [$33 each] -- ↓ *capital accounts* by *FMV* [$53 each]