Problem 3. David, Stephen and Graham comprise a partnership organized several years ago to invest in and develop land. Each partner contributed $100 to the partnership at its inception. The partnership used this money to purchase a tract of land as an investment and to purchase a second tract and develop this second tract as a residential subdivision. The partnership has realized no income yet but plans to sell the subdivision lots later this year and to sell the land held for investment next year. Its balance sheet is as follows:

Assets Liabilities & Capital BasisBookLiabilities Lots$30$150None Land270450 Total$300$600 Capital Accounts TaxBook David$100$200 Stephen100200 Graham100200 Total$300$600

David has substantial net operating loss deductions from other investments and little income to offset them. The partnership's accountant has suggested that this situation might be exploited by distributing the lots to David before they are sold. The partnership would "book- up" the capital accounts of the partners and the assets of the partnership to fair market value as permitted under 1.704-1(b)(2)(iv)(f). David's interest in capital and future book profits would be decreased from one-third to one-ninth to reflect this disproportionate distribution. The interests of Stephen and Graham in book capital and future book profits and losses would increase to four-ninths each.

What are the tax consequences of the distribution to the partnership, David, Stephen and Graham?