Charlie Brown and Linus are equal partners in a general partnership that owns several residential multifamily real estate rental properties. Typically each tenant signs a one year lease with no renewal options. Over the past three years, their average annual rent collected was about $30 million annually from these properties. When they purchased the properties, Charlie Brown and Linus thought that they would be able to increase rents by about ten percent annually as the leases renewed. Because they wanted to maximize their return on investment, they financed the acquisition of their properties with 20% equity and 80% debt. Several years later, they now realize that they were overly optimistic about subsequent rent increases as they were only able to achieve a five percent annual increase in rents. Consequently, the interest expense associated with the loans is consuming all of the net operating income generated by the properties. In order to enhance their return on investment, Charlie Brown and Linus are seeking to recapitalize their venture. If they bring in a new investor to provide additional equity capital, they can refinance the mortgages that are collateralized by the rental properties at a much lower interest rate. Linus' sister, Lucy, is a successful business person who conducts all of her operations through a C corporation. Lucy has indicated that she is willing to invest through her C corporation. Charlie Brown and Linus know that Lucy is very bossy, and while they want her to invest, they don't want her to have any input into how the day to day business is run.

They have devised the following restructuring of the existing partnership. The partnership will be converted from a general partnership to a limited partnership. Charlie Brown and Linus will each have a general partnership interest of .5% (for a total 1% general partnership interest). The remainder of Charlie Brown and Linus' interests will be converted to limited partnership interests. Lucy's corporation will contribute cash in exchange for a 33% interest in the partnership. After Lucy is admitted the partnership interests will be as follows: General partners Charlie Brown .5% Linus .5% Limited Partners Charlie Brown 33% Linus 33% Lucy's corporation 33% One advantage of admitting Lucy to the partnership as a limited partner is that, because she is a close personal relative of an existing general partner, the partnership is exempt from having to file any registration documents with the Securities & Exchange Commission or any state securities regulators. The partnership presently uses the cash method of accounting.

Questions: Can the partnership continue to use the cash method? Why or why not? Would the answer change if Lucy formed a limited liability company which she owned directly (i.e., not through her C corp.) to invest as a limited partner? Why or why not? If the partnership adopts the accrual method of accounting, are there any other planning ideas that are available to accrual method taxpayers to obtain additional tax benefits?