Blythe and Ella acquired a 5-acre tract of land on 8th Avenue South in the Melrose area of Nashville for $1,000,000 in 2010, as tenants in common. Each of Blythe and Ella contributed $100,000 to the down payment and they financed the remaining $800,000 of the purchase price with a 10-year, interest-only loan at 5% interest from a local credit union. The loan was secured by the 5-acre lot and any current and future structures attached thereto. Blythe and Ella were jointly and severally liable for the loan (i.e., recourse to each) and they had not entered into any separate contribution or sharing agreements between them with respect to this loan.

The only structure on the lot was a dilapidated building that had been used by a car dealership several years ago. Although Blythe and Ella knew they could not rent the building given its current state of disrepair, they planned to install a self-pay parking terminal and charge $2/hour with a maximum of $20 for 24 hours to park in the lot that had been used by the dealership for its inventory.

Initially, the plan was to generate enough parking revenue to cover the cash expenses interest on the loan, property taxes, insurance, electric bills to power the lights in the parking lotand then sell the lot to a developer whenever "they felt the time was right". Blythe and Ella agreed to share all profits and losses, including any gain or loss on the sale of the land, equally.

The revenue from the parking lot was deposited into a joint checking account at the credit union that financed the purchase. Although both Blythe and Ella had signature and check-writing authority on the account, they agreed that Ella, who was a CPA, would maintain the check register and reconcile the monthly bank statements. Between the two of them, but not documented formally in any sort of agreement, Blythe told Ella that she did not need to get her consent whenever she needed to make a payment of less than $1,000. For amounts equal to or in excess of $1,000, both Blythe and Ella had to agree on whether to make the expenditure; if they could not reach an agreement, the expenditure would not be undertaken.

QUESTION #1 (100 points)

Blythe is one of your good friends and you mentioned to her that you were taking a passthroughs tax class at Lipscomb. She told you that ever since 2010, Ella would calculate the annual net profit or loss from the parking lot and they each would report their share of the net profit or loss as rental income (or loss) on their respective individual income tax returns.

1. (a)Blythe asked you whether they had been reporting this income (or loss) correctly on their individual income tax returns and whether they should have been filing a partnership tax return since 2010.
2. (b)Blythe also told you that she and Ella had been discussing forming a state law limited liability entity to hold this parcel of real property, but Ella was reluctant to do so because she thought it was "too complicated". Blythe solicited your thoughts on this issue and specifically whether such entity should be classified as a partnership or an S corporation for federal income tax purposes.
3. (c)Finally, just as lunch was ending, Blythe asked you about the 20% deduction for qualified business income that she had read about online and wanted your thoughts on whether that deduction might apply to this activity and if not, how should she and Ella structure their arrangement to do so.