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