G and L form a limited partnership. L contributes $2,000, and G, who does not contribute cash, will use her immense brainpower to earn money for the partnership. The business deal is that L receives all cash distributions until L has received back the amount of her capital investment. Subsequent distributions will be split 80% to L and 20% to G.

In Year 1, the partnership buys two parcels of land, Blackacre and Whiteacre, each for $1000. At year end, the partnership sells Blackacre for $1100 and distributes the entire proceeds of $100 to L. How should the $100 gain on Blackacre be allocated between L and G to be consistent with the business deal?

suppose in #4 that the business deal is that L is to receive all cash distributions until L received an amount equal to her capital investment, plus a preferred return of 4% annually on that investment (until distributed), before any cash is distributed to G. The partnership’s cash flow distributions provisions (i.e., “the waterfall”) provide that

1. L is entitled to distributions in the amount of her initial contribution of $2000,
2. L is entitled to distributions equal to her accumulated preferred return,
3. G is entitled to her “catch-up”, a distribution equal to 20 of the sum of (ii) and (iii), and
4. The balance, if any, is to be distributed 80:20 between L and G.

How should the $100 gain on Blackacre be allocated?

Further question: In year 2, the partnership continues to hold Whiteacre, but does not otherwise engage in any tax significant transactions. How should the partnership take into account L’s 4% preferred return?