A and B form a partnership on January 1 of Year 1. Each makes a cash contribution to the partnership of $80,000. The partnership purchases depreciable equipment for $160,000. The partnership agreement provides that all income and loss are allocated equally, except that all depreciation deductions are allocated to A. Assume (Code provisions to the contrary notwithstanding) that the equipment generates depreciation deductions of $40,000 per year and that in all years the partnership breaks even except for depreciation deductions, and so incurs a loss each year of $40,000.

a. Generally describe what provisions the partnership agreement will have to contain in order for the allocations to A to be respected.

b. Assuming the partnership agreement contains all such provisions, compute capital accounts for A and B on formation and at the end of the first three years of partnership operations.

c. How would your answers to 'a' and 'b' change if A does not have a deficit restoration obligation?

d. Assume the same facts as in 'c' except that in Year 2 it is reasonably expected that in Year 3 the partnership's equipment will appreciate in value by $20,000, and the partnership will borrow $20,000 against the equipment and distribute $10,000 to each partner in Year 3. How will your answer change? Would it make a difference if A had a limited deficit restoration obligation of $20,000?

e. Assume in 'b' of the problem that the equipment is sold on January 1 of Year 3 for $180,000. State how the gain should be allocated and compute the partner's capital accounts immediately before the liquidation of the partnership. Does the gain allocation make sense? Do you have any alternative suggestions for how the gain might be allocated?