In 2017, X and Y form a partnership solely to purchase equipment for leasing. The cost of the equipment is $1,000. X and Y each contribute $50 to the partnership and the partnership obtains a $900 recourse loan to purchase the equipment. The partnership enters into an 8-year net lease with a financially sound lessee. Because the equipment is 5-year property for purposes of Sec. 168, the partnership expects to have tax losses for the first three years of its operations of $100, $100 and $50 respectively. For the remaining five years of the initial lease, it expects to generate taxable profits of $75, $75, $100, $100 and $100.

The XY partnership agreement satisfies the three basic requirements of the economic effect test of Reg. Sec. 1.704-1(b)(2)(ii)(b). The partnership allocates 90% of all partnership income and losses to X and 10% to Y until such time as the amount of taxable income that has been allocated to the partners equals the amount of previously allocated tax losses. Thereafter, all partnership allocations will be allocated 50-50.

On the assumptions that X is at all relevant times in the 40% tax bracket and that Y has an NOL that will expire in three years, will these allocations be respected.