Chapter 7 Taxing partnership operations - determining the partners' distributive shares

Problem area 7

Questions

1.Q and R form the QR Partnership, a general partnership, each contributing $30,000. During its first year of operation, the partnership loses $10,000. Q and R agree that the loss should be allocated to R. What requirements must be met for the allocation to have economic effect? What are the tax and capital-account effects of the allocation?

2.A and B form the AB Partnership, a general partnership, with cash contributions of $50,000 each. Each partner has a one-half interest in the capital, profits, and losses of the partnership and an unlimited obligation to restore any deficit balance in the partner's capital account on liquidation. The partnership purchases an apartment building for $100,000 on January 1, Year 1. A wishes to shelter income from non-partnership activities, so the partnership agreement allocates to A the entire depreciation deduction of $5,000 per year. The partners agree to reflect the depreciation allocation by appropriately adjusting A's capital account and to distribute proceeds on liquidation in accordance with their capital accounts. Assume that other expenses exactly equal income. Does the allocation possess economic effect? what cash would be distributed to the partners on January 1, Year 4, if the property were sold alternatively for $85,000, $100,000, or $70,000 and the partnership subsequently liquidated? what additional provisions should be included in the partnership agreement in the event that the partners do not agree to restore any deficit balances in their capital accounts?

3.A and B form the AB Partnership, a general partnership, each contributing $5,000. The partnership agreement requires the partners to restore any deficit balance in their respective capital accounts upon liquidation. The partnership borrows $90,000 on a recourse basis and purchases a building for $100,000 on January 1, Year 1. Assuming the depreciation expense is $5,000 per year, the parties agree that all depreciation will be allocated to A, and other expenses exactly equal income, what are their capital accounts on January 1, Year 4? what are their tax bases? what results if the building is sold alternatively for $85,000, $100,000, or $70,000 and thereafter the partnership satisfies the liability?

4.At the end of the partnership year, when the amounts and character of income and deductions are certain, the equal AB Partnership allocates all items equally between its two partners, except for $100 of tax-exempt interest, which it allocates entirely to A, and $100 of fully taxable interest, which it allocates entirely to B. Assuming the capital accounts are properly adjusted and the partnership agreement provides that distributions will be in accordance with the capital accounts, will the allocation have substantial economic effect if A and B are similarly situated taxpayers? What if the partners wanted to reallocate distributive shares on an amended tax return or a late return?

5.A and B enter into a partnership agreement on January 1, Year 1. A contributes $25,000 cash and agrees to devote his full-time services to the partnership. B, who is and expects to continue to be in a higher tax bracket than A, contributes $500,000 in cash. The agreement provides that 99 percent of all deductions and taxable losses will be allocated to B until there is net taxable income, whereupon B will be allocated an amount of income equal to her prior allocated losses. Thereafter, all taxable income or loss will be allocated equally. Determine the substantiality of the partnership's allocation scheme under the following circumstances:

a. The partnership is formed for widcat oil drilling of a particular piece of property.

b. The partnership is formed to acquire and lease machinery. Because of the nature of the machinery and its depreciable life, as well as the predictable nature of the income expected from machinery leases entered into by the partnership, there is a strong likelihood at the time of formation that B's allocations will be offset completely by December 31, Year4.

c. In b. above, assume that the allocations are not expected to be offset completely until December 31, Year 4.

6.What result in 2. above where the property is sold alternatively for $85,000, $100,000, or $70,000, if A and B agree that any gain (to the extent of prior depreciation allocations) arising on the disposition of the property will be credited to A? Do the original allocations and chargeback allocation have economic effect? Is this effect substantial?