Leland Real Estate LP The Leland Real Estate Limited Partnership (Leland) was formed on January 1, Year One, to purchase, construct, and manage residential real estate. The partnership adopted the accrual method of accounting and a calendar year for federal income tax purposes. On February 2, Year One, Leland purchased the Longstreet Manor apartment complex for a total price of $5,000,000. Of the purchase price, $1,000,000 was allocated to the land, and $4,000,000 was allocated to the buildings. Leland financed the acquisition by obtaining a fifteen year, three percent interest rate, $4,500,000 mortgage from a lender that is unrelated to any of the Leland partners. The mortgage is secured by the apartment complex, but it is fully recourse to the partnership. No other properties were purchased during the year. The Leland partnership agreement provides that the corporate general partner, KLM Properties Inc (KLM), will receive an annual management fee equal to 5 percent of the gross rental income earned by the partnership. This fee is reasonable by local industry standards. In return for the fee, KLM will provide all necessary services, so that Leland need not hire any partnership employees. All partnership taxable income, gain, or loss will be allocated 5 percent to KLM and 95 percent to the limited partners, based on each limited partner's specified percentage interest. The partnership agreement provides that partners' capital accounts will be determined and maintained in accordance with the $704(b) regulations, and that liquidating distributions will be made in accordance with capital account balances. As the general partner, KLM must restore any deficit balance in its capital account upon liquidation; limited partners are not subject to this deficit restoration requirement. However, the partnership agreement does contain a "qualified income offset" to satisfy the alternate test for economic effect. On January 20, Year One, your client Josie Chamberlain contributed undeveloped land, known as Claremont Corners, and various intangible assets such as goodwill associated with her reputation, to Leland in exchange for a 38 percent limited partnership interest (i.e., Josie will receive 40 percent of the 95 percent allocations to the limited partners). KLM, as general partner, agreed to this exchange because the land is situated ideally for future development as residential rental property. Josie inherited Claremont Corners a number of years ago, and her tax basis in the property is $50,000; the appraised value of the land at the date of contribution was $75,000, and the entry to Josie's partnership capital account properly reflected this contributed value. The partnership agreement provides that limited partners cannot be called upon to make mandatory additional capital contributions in the future Chamberlain is a plastic surgeon employed by a medical professional corporation. During Year One, she received a salary of $330,000 for her medical services. She also earned $19,400 of dividend and capital gain income from her mutual funds, and an allocation of $20,600 of operating business income from an oil and gas partnership in which she has a 0.3 percent limited partnership interest. KLM General Partner Chamberlain Limited Partner Other Limited Partners Leland Real Estate Longstreet Manor Claremont Corners Other Realty A summary of Leland's operating revenues and expenses for Year One is attached. Compute Leland's taxable income or loss for the period, and determine the amount of the income or loss that is (1) allocable to and (2) deductible by Josie Chamberlain on her Year One federal individual income tax return. Leland Real Estate Limited Partnership Operating Revenues and Expenses For January 1 December 31, Year One Gross rental revenues $ 2,100,000 Operating expenses for properties Repairs and maintenance Interest expense Property taxes $ 1,700,000 212,000 126,000 110,000 2,148,000 Net cash flow from operations $ (48,000) *Leland financed the negative cash flow from operations with short term recourse borrowing. The management fee is not included in the above expense but should be taken into account in determining the solution Early in Year Two, KLM's board of directors fired the corporation's existing management and replaced them with a much more conservative group of corporate executives. The new management team immediately decided to liquidate several of the corporation's speculative investments, including its interest in Leland. At a partners' meeting held on January 29, Year Two, the partners unanimously voted to sell Longstreet Manor and Claremont Corners, pay off all existing partnership liabilities, and distribute any net cash remaining in complete liquidation of the partnership. Buyers for the two properties were located quickly. These buyers are unrelated to any of the Leland partners. The disposition occurred during Year Two in the following manner. On April 22, the partnership sold Claremont Corners for $550,000 cash. On May 4, the partnership sold the Longstreet Manor apartment complex for $1,600,000 cash plus the assumption of the $4,200,000 unamortized principal balance of the mortgage on the property On May 30, Leland was dissolved under state law, and all remaining partnership assets (cash) were distributed properly to the Leland partners. For the period from January 1 through May 30. Year Two, Leland generated a net operating loss of $311,000 (including properly computed MACRS depreciation on the Longstreet Manor property). Analyze the tax consequences of the Year Two partnership operations, asset sales, and liquidation for Josie Chamberlain. Josie's other sources of income remained constant from the prior year. Part I Leland taxable income/loss needs additional computations of deductions for cost recovery and guaranteed payments. Construct Chamberlain's capital account and tax basis in her partnership interest, as of the date of her contribution. Chamberlain's allocation might be restricted by her capital account balance (8704(b)]. Use the constructive liquidation rules to derive Chamberlain's deductible Year One loss [$704(d)]. Update Chamberlain's capital account and tax basis as of the end of the year. Apply the rules of $$ 465 and 469 to compute Chamberlain's deduction for her allocated loss. Part II Compute Year Two cost recovery for the realty sold in that year. What is the nature of the gain on the Leland sale of the realty? It never was used in a trade or business. Consider also any unrecaptured 1250 gain. Does Chamberlain receive a cash distribution as part of the entity's liquidation? Remember that Chamberlain has a suspended $469 loss going into Year Two a Leland Real Estate LP The Leland Real Estate Limited Partnership (Leland) was formed on January 1, Year One, to purchase, construct, and manage residential real estate. The partnership adopted the accrual method of accounting and a calendar year for federal income tax purposes. On February 2, Year One, Leland purchased the Longstreet Manor apartment complex for a total price of $5,000,000. Of the purchase price, $1,000,000 was allocated to the land, and $4,000,000 was allocated to the buildings. Leland financed the acquisition by obtaining a fifteen year, three percent interest rate, $4,500,000 mortgage from a lender that is unrelated to any of the Leland partners. The mortgage is secured by the apartment complex, but it is fully recourse to the partnership. No other properties were purchased during the year. The Leland partnership agreement provides that the corporate general partner, KLM Properties Inc (KLM), will receive an annual management fee equal to 5 percent of the gross rental income earned by the partnership. This fee is reasonable by local industry standards. In return for the fee, KLM will provide all necessary services, so that Leland need not hire any partnership employees. All partnership taxable income, gain, or loss will be allocated 5 percent to KLM and 95 percent to the limited partners, based on each limited partner's specified percentage interest. The partnership agreement provides that partners' capital accounts will be determined and maintained in accordance with the $704(b) regulations, and that liquidating distributions will be made in accordance with capital account balances. As the general partner, KLM must restore any deficit balance in its capital account upon liquidation; limited partners are not subject to this deficit restoration requirement. However, the partnership agreement does contain a "qualified income offset" to satisfy the alternate test for economic effect. On January 20, Year One, your client Josie Chamberlain contributed undeveloped land, known as Claremont Corners, and various intangible assets such as goodwill associated with her reputation, to Leland in exchange for a 38 percent limited partnership interest (i.e., Josie will receive 40 percent of the 95 percent allocations to the limited partners). KLM, as general partner, agreed to this exchange because the land is situated ideally for future development as residential rental property. Josie inherited Claremont Corners a number of years ago, and her tax basis in the property is $50,000; the appraised value of the land at the date of contribution was $75,000, and the entry to Josie's partnership capital account properly reflected this contributed value. The partnership agreement provides that limited partners cannot be called upon to make mandatory additional capital contributions in the future Chamberlain is a plastic surgeon employed by a medical professional corporation. During Year One, she received a salary of $330,000 for her medical services. She also earned $19,400 of dividend and capital gain income from her mutual funds, and an allocation of $20,600 of operating business income from an oil and gas partnership in which she has a 0.3 percent limited partnership interest. KLM General Partner Chamberlain Limited Partner Other Limited Partners Leland Real Estate Longstreet Manor Claremont Corners Other Realty A summary of Leland's operating revenues and expenses for Year One is attached. Compute Leland's taxable income or loss for the period, and determine the amount of the income or loss that is (1) allocable to and (2) deductible by Josie Chamberlain on her Year One federal individual income tax return. Leland Real Estate Limited Partnership Operating Revenues and Expenses For January 1 December 31, Year One Gross rental revenues $ 2,100,000 Operating expenses for properties Repairs and maintenance Interest expense Property taxes $ 1,700,000 212,000 126,000 110,000 2,148,000 Net cash flow from operations $ (48,000) *Leland financed the negative cash flow from operations with short term recourse borrowing. The management fee is not included in the above expense but should be taken into account in determining the solution Early in Year Two, KLM's board of directors fired the corporation's existing management and replaced them with a much more conservative group of corporate executives. The new management team immediately decided to liquidate several of the corporation's speculative investments, including its interest in Leland. At a partners' meeting held on January 29, Year Two, the partners unanimously voted to sell Longstreet Manor and Claremont Corners, pay off all existing partnership liabilities, and distribute any net cash remaining in complete liquidation of the partnership. Buyers for the two properties were located quickly. These buyers are unrelated to any of the Leland partners. The disposition occurred during Year Two in the following manner. On April 22, the partnership sold Claremont Corners for $550,000 cash. On May 4, the partnership sold the Longstreet Manor apartment complex for $1,600,000 cash plus the assumption of the $4,200,000 unamortized principal balance of the mortgage on the property On May 30, Leland was dissolved under state law, and all remaining partnership assets (cash) were distributed properly to the Leland partners. For the period from January 1 through May 30. Year Two, Leland generated a net operating loss of $311,000 (including properly computed MACRS depreciation on the Longstreet Manor property). Analyze the tax consequences of the Year Two partnership operations, asset sales, and liquidation for Josie Chamberlain. Josie's other sources of income remained constant from the prior year. Part I Leland taxable income/loss needs additional computations of deductions for cost recovery and guaranteed payments. Construct Chamberlain's capital account and tax basis in her partnership interest, as of the date of her contribution. Chamberlain's allocation might be restricted by her capital account balance (8704(b)]. Use the constructive liquidation rules to derive Chamberlain's deductible Year One loss [$704(d)]. Update Chamberlain's capital account and tax basis as of the end of the year. Apply the rules of $$ 465 and 469 to compute Chamberlain's deduction for her allocated loss. Part II Compute Year Two cost recovery for the realty sold in that year. What is the nature of the gain on the Leland sale of the realty? It never was used in a trade or business. Consider also any unrecaptured 1250 gain. Does Chamberlain receive a cash distribution as part of the entity's liquidation? Remember that Chamberlain has a suspended $469 loss going into Year Two a