Fred and Manuel each contribute $100,000 to the newly formed FM P/S in exchange for a 50% interest. The ps uses the available funds to acquire equipment costing $160,000 and to fund current operating expenses. The ps agreement provides that the depreciation will be allocated 95% to Fred and 5% to Manuel. All other items of income and loss will be allocated equally between the partners. Upon liquidation of the ps, property will be distributed to the partners in accordance with their capital account balances. Any partners with a negative capital account must contribute cash in the amount of the negative balance to restore the capital account to zero.

In its first year of operations, the ps reported an ordinary loss (before depreciation) of $40,000 and depreciation expense of $32,000. In its second year, operations broke even (no gain or loss), and the ps reported depreciation expense of $51,200. On the first day of the third year, the ps sold the equipment for $120,000 and distributed the cash in accordance with the ps agreement. The ps was liquidated at this time.

1. Calculate the partners AB in their ps interests at the end of the first and second tax years. Are any losses suspended?

2. Calculate the partners bases in their ps interest after reflecting any gain or loss on thedisposal of the equipment.

3. How will ps cash balances be distributed to the partners on liquidation?

4. Does the allocation provided in the ps agreement have economic effect?

5. What observation can you make regarding the value of a deduction to each partner?