Nathan Fairplay and Joseph Dealer invested together in real estate for many years. Recently, Nathan died and his daughter Sylvia inherited all his real estate buildings. Nathan and Joseph owned, as tenants-in-common, an apartment house at 641 Lincoln, a supermarket leased to Super Wooper Supermarkets at 1200 Baseline and a medical office building at 231 Broadway. Nathan and Joseph each had provided one-half of the down payments for the properties and had paid one-half off all expenses including amortization of the mortgages. They each had reported one-half of the income and deducted one-half of the expenses, including depreciation computed using the most accelerated rate available, on their personal income tax returns. The fair market value of the investments has remained the same since Nathans death. The mortgage liability on, and the fair market value of, each property is at follows: 641 Lincoln $90,000 liability, $210,000 value; 1200 Baseline, $180,000 liability, $240,000 value; and 231 Broadway, $300,000 liability, $420,000 value. Josephs adjusted basis in 641 Lincoln is $62,000; in Baseline it is $90,000; and in 231 Broadway it was $105,000. The properties were acquired by Nathan and Joseph at various times between 2 and 10 years ago. Sylvia, being young and aggressive, wants to expand the real estate endeavors using the equity in the present properties as a means of raising capital for new projects. Joseph is willing to expand but does not want to incur any further liabilities nor take an active part in the expanded operation. Sylvias attorney has suggested the following to accomplish the parties desires. First, the three present mortgages will be consolidated into a $570,000 mortgage covering all three properties. Joseph and Sylvia will contribute the properties subject to the mortgage to a limited liability company. The limited liability company will assume the mortgage liability and Sylvia and Joseph will be released. Sylvia will receive, for her contribution, a 30% interest in limited liability company. Pursuant to the limited liability companys operating agreement, Sylvia will be the managing member. Joseph also will receive a 30% interest in the liability company. The remaining 40% of the limited liability company will be sold to various investors in order to raise the necessary capital for expansion. The attorney has suggested to Sylvia that, in order to make the interests in the limited liability company more saleable, it should be organized so that the outside investors have the opportunity to realize income tax losses, substantial tax-free cash distributions and no taxation on the gain inherent in the property contributed by Joseph and Sylvia. He has suggested that the following provisions be included in the liability companys operating agreement:

The members shall share in any current distribution of cash or property made by the libited liability company in accord with their membership interests.

The members shall share in a distribution or distributions of cash and/or property in liquidation of the limited liability company in the following order. First, each member shall receive the amount of his or her drawing account. Second, each member shall receive the amount of his or her capital account. Lastly, if the distribution or distributions are in excess of the total of the capital accounts of all members, each member shall share in such excess in accord with his or her interest in the limited liability company.

Contributed Property

Depreciation and gain or loss on the sale of contributed property shall be allocated for income tax purposes as follows:

To the members other than those who contributed the property, the amount of depreciation or gain or loss on sale computed by using the values at which the properties were contributed; and

To the members who contributed the property, the balance of the depreciation or the balance of the gain or loss that is allowed for income tax purposes.

The members realize that the income tax regulations impose a ceiling on the amount of depreciation or gain or loss on sale that may be allocated under this provision to the members other than those who contributed the property. If the ceiling applies, it is agree that it will limit the allocation otherwise required by subsection A. above.

Contributed Property shall mean the property located at 641 Lincoln, 1200 Baseline, and 231 Broadway and any property which such described property is exchanged for, or converted into, in a transaction qualifying for treatment under Internal Revenue Code Section 1031 or 1033 of Internal Revenue Code of 1986, as amended, provided that the adjusted basis of the property received in exchange, or into which the described property is converted, immediately after the exchange or conversion is equal to, or less than, the adjusted basis of the described property immediately before the exchange or conversion.

Allocation of Expenses: Any expense, loss, deduction or credit paid or incurred by the limited liability company or to which the limited liability company is entitled, other than any such item related to the contributed property, shall be allocated to the members who contribute cash to the limited liability company in return for their interests and their transferees, successors and assigns in accord with the percentage that each ones interest bears to 40%, so long as the total amount of such items allocated to such members and their transferees, successors and assigns and to any one thereof does not exceed the total amount of cash contributed by such members or any one thereof. All such allocations shall be subject to the following conditions:

When such items are so allocated, the capital account of each member receiving such an allocation shall be reduced by the amount of such items allocated to the member; and

When the amount of such items so allocated exceeds the total amount of cash contributed such members, the excess shall be allocated to all members in accord with their interests.

Allocation of Other Income and Expenses: All items of income, gain, loss, deduction or credit, other than those specifically allocated in provisions III and IV, above, shall be allocated to the members in accord with their interests.

For her services as managing member and in the management of the limited liability companys investments, Sylvia Fairplay shall receive $36,000 a year or 2% of net annual cash flow from the operation of the limited liability company, which is greater, provided that in no event will her compensation exceed $75,000 a year.

Before finalizing the organization of the limited liability company and the transactions described above, Sylvia and Joseph have asked for your advice as a tax expert with respect to the tax effects of the above proposal. Will the proposal result in any adverse income tax effects? Do you have any suggested changes in, modifications of, or additional provisions for, the partnership agreement which will better carry out the desires of the parties?