This question is based on the partnerships MC question 1 (pasted at the end below). One of the most important record- keeping items for a partnership is the basis of each partner in the partnership. This is important because when a partnership liquidates, any excess over basis is gain and any deficit is a loss. 1. Explain why it is to the benefit of each partner to have a high basis in the partnership. This is true for any asset you own. For tax purposes, you want to have a high basis. Why? (Explain in about 50 words) 2. What was the total capital in the partnership (i.e. total basis of all existing partners) before Kelly contributed the service? Not a trick question. (You may want to answer question 5 below first). 3. How much additional capital is being contributed to the partnership by Kelly's services? 4. What is the partnership's total capital after Kelly's contribution? 5. Prepare and attach form 1065 Schedule M-2 (Analysis of Partners' Capital Accounts) to the best of your ability based on the information provided in the MC question. 6. Comment on what you have learned and/or on the sources you used to answer the questions above. [1] On June 1 of the current year, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock's net assets at that date had a basis of $70,000 and a fair market value of $100,000. In Kelly's current-year income tax return, what amount must Kelly include as income from the transfer of the partnership interest? A. $7,000 ordinary income. B. $7,000 capital gain. C. $10,000 ordinary income. D. $10,000 capital gain. The correct answer is C. This question is based on the partnerships MC question 1 (pasted at the end below). One of the most important record- keeping items for a partnership is the basis of each partner in the partnership. This is important because when a partnership liquidates, any excess over basis is gain and any deficit is a loss. 1. Explain why it is to the benefit of each partner to have a high basis in the partnership. This is true for any asset you own. For tax purposes, you want to have a high basis. Why? (Explain in about 50 words) 2. What was the total capital in the partnership (i.e. total basis of all existing partners) before Kelly contributed the service? Not a trick question. (You may want to answer question 5 below first). 3. How much additional capital is being contributed to the partnership by Kelly's services? 4. What is the partnership's total capital after Kelly's contribution? 5. Prepare and attach form 1065 Schedule M-2 (Analysis of Partners' Capital Accounts) to the best of your ability based on the information provided in the MC question. 6. Comment on what you have learned and/or on the sources you used to answer the questions above. [1] On June 1 of the current year, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock's net assets at that date had a basis of $70,000 and a fair market value of $100,000. In Kelly's cument-year income tax return, what amount must Kelly include as income from the transfer of the partnership interest? A. $7,000 ordinary income. B. $7,000 capital gain. C. $10,000 ordinary income. D. $10,000 capital gain. The correct answer is C. A. The amount of $7,000 is based on the adjusted basis of the partnership's net assets. B. The amount of $7,000 is based on the adjusted basis of the partnership's net assets, and the amount recognized should be characterized as ordinary income since it is compensation for services. C. An individual must recognize compensation income when a partnership interest is received in exchange for services (whether current or past) rendered (Reg. 1.721-1(b)(1). The receipt of a capital interest in a partnership for services must be included in the year of receipt under Sec 83. The income that should be recognized is the $10,000 ($100,000 -10%) fair market value of the partnership interest received unless the interest is nontransferable or subject to a substantial risk of forfeiture. The income is ordinary because it is compensation for services. D. Compensation for services is not characterized as a capital gain