Your clients, Grayson Investments, Inc. (Ana Marks, President), and Blake Caldwell, each contributed $200,000 of cash to form the Realty Management Partnership, a limited partnership. Grayson is the general partner, and Blake is the limited partner. The partnership used the $400,000 cash to make a down payment on a building. The rest of the building’s $4,000,000 purchase price was financed with an interest-only nonrecourse loan of $3,600,000, which was obtained from an independent third-party bank.

The partnership allocates all partnership items equally between the partners except for the MACRS deductions and building maintenance, which are allocated 70% to Blake and 30% to Grayson. The partnership wants to satisfy the “economic effect” requirements of Reg. §§ 1.704–1 and 1.704–2 and will reallocate MACRS, if necessary, to satisfy the requirements of the Regulations.

Under the partnership agreement, liquidation distributions will be paid in proportion to the partners’ positive capital account balances. Capital accounts are maintained as required in the Regulations. Grayson Investments has an unlimited obligation to restore its capital account, while Blake is subject to a qualified income offset provision.

Assume that all partnership items, except for MACRS, will net to zero throughout the first three years of the partnership operations. Also assume that each year’s MACRS deduction will be $200,000 (to simplify the calculations).

Draft a letter to the partnership, evaluating the allocation of MACRS in each of the three years under Reg. §§ 1.704–1 and −2. The partnership’s address is 53 East Marsh Ave., Smyrna, GA 30082. Do not address the “substantial” test.