1. Explain why it is beneficial for each partner to have a high basis in the partnership. This is true for any asset you own. For tax purposes, you want to have a high basis. Why?

1. What was the total capital in the partnership (i.e. total basis of all existing partners) before Kelly contributed the service?

1. How much additional capital is being contributed to the partnership by Kellys services?

1. What is the partnerships total capital after Kellys contribution?

1. Prepare and attach form 1065 Schedule M-2 (Analysis of Partners Capital Accounts) to the best of your ability based on the information provided in the MC question.

1. Comment on what you have learned.

[1] On June 1 of the current year, Kelly received a 10% interest in Rock Co., a partnership, for sevices contributed to the partnership. Rock's net assets at that date had a basis of $70,000 and a fair market value of $100,000. In Kelly's current-year income tax retum, what amount must Kelly include as income from the transter of the partnership interest? A. $7,000 ordinary income. B. $7,000 capital gain. C. $10,000 ordinary income. D. $10,000 capital gain. The correct answer is C. A. The amount of $7,000 is based on the adjusted basis of the partnership's net assets. B. The amount of $7,000 is based on the adjusted basis of the partnership's net assets, and the amount recognized should be characterized as ordinary income since it is compensation for services. C. An individual must recognize compensation income when a partnership interest is received in exchange for services (whether current or pasti) rendered [Reg. 1.721-1(b)(1)]. The receipt of a capital interest in a partnership for services must be included in the year of receipt under Sec. 83. The income that should be recognized is the $10,000($100,00010%) fair market value of the partnership interest received unless the interest is nontransferable or subject to a substantial risk of forfeiture. The income is ordinary because it is compensation for services. D. Compensation for services is not characterized as a capital gain. Schedule M-2 Analysis of Partners' Capital Accounts