PARTNERSHIP FORMATION

Eb Dawson, Ralph Monroe and Alf Monroe form a general partnership (Pixley Plumbing) to conduct a plumbing business and agree to share all profits and losses equally. They also wish to have their initial capital in the partnership to be $10,000 each. All three partners are skilled plumbers and will perform services as co-proprietors in the new partnership. Eb, the partner with the most liquid assets, will contribute $10,000 in cash. Ralph, who previously conducted his plumbing business as a sole proprietor, contributes $5,000 of zero-basis accounts receivable and $5,000 of installment notes with a $1,000 basis. Alf, who previously worked for her father before his retirement last year, contributes trucks and equipment. These assets were given to Alf when her father retired. The equipment and trucks have an aggregate adjusted basis of $2,000 and a fair market value of $9,000. To make up for the $1,000 of capital shortage Alf has suggested one of two alternatives. Under Alternative #1, Alf contributes fifteen faucets and knobs she had made by hand over the past two years in her spare time. The designs are new and have never been marketed in the trade. However, if this design catches on as a fad, the partnership will make a substantial amount of money. Her tax basis comes to $500 (the raw materials involved); Eb and Ralph (mostly out of generosity and team spirit) agree that the items are worth $1,000 and will credit her capital with $1,000. Under Alternative #2, Alf contributes a letter of commitment to perform all of the plumbing work in a proposed shopping center. Alf handled all the negotiations for two years while working for her father before the commitment finally came through. Unfortunately, the commitment grants the contract to the fathers business and does not say whether a business without Alfs father could be appointed to do the job. This letter (along with all the other assets) was given to Alf when her father retired. Alfs basis in the letter is zero. As with the faucets and knobs, Eb and Ralph agree that the commitment's fair market value equals $1,000 and Alf's capital account will be credited with this value.

Prepare a tax research memorandum to the client file and a letter to Eb, Ralph and Alf explaining the basic tax consequences to Eb, Ralph, Alf, and the partnership from these contributions including both of Alfs alternatives.