Carrie D’Lake, Reed A. Green, and Doug A. Divot share a passion for golf and decide to go into the golf club manufacturing business together. On January 2, 2014, D’Lake, Green, and Divot form the Slicenhook Partnership, a general partnership. Slicenhook’s main product will be a perimeter-weighted titanium driver with a patented graphite shaft. All three partners plan to actively participate in the business. The partners contribute the following property to form Slicenhook:

Carrie had recently acquired the land with the idea that she would contribute it to the newly formed partnership. The partners agree to share in profits and losses equally. Slicenhook elects a calendar year end and the accrual method of accounting.

In addition, Slicenhook borrows $1,500,000 from BigBank at the time the contributions were made. Slicenhook uses the proceeds from the loan and the cash contributions to build a state-of-the-art manufacturing facility ($1,200,000), purchase equipment ($600,000), and produce inventory ($400,000). With the remaining cash, Slicenhook invests $45,000 in the stock of a privately owned graphite research company and retains $55,000 as working cash.

Slicenhook operates on a just-in-time inventory system so it sells all inventory and collects all sales immediately. That means that at the end of the year, Slicenhook does not carry any inventory or accounts receivable balances. During 2014, Slicenhook has the following operating results:

The partnership is very successful in its first year. The success allows Slicenhook to use excess cash from operations to purchase $15,000 of tax-exempt bonds (you can see the interest income already reflected in the operating results). The partnership also makes a principal payment on its loan in the amount of $300,000 and a distribution of $100,000 to each of the partners on December 31, 2014.

The partnership continues its success in 2015 with the following operating results:

The operating expenses include a $1,800 trucking fine that one of their drivers incurred for reckless driving and speeding and meals and entertainment expense of $6,000.

By the end of 2015, Reed has had a falling out with Carrie and Doug and has decided to leave the partnership. He has located a potential buyer for his partnership interest, Indie Ruff. Indie has agreed to purchase Reed’s interest in Slicenhook for $730,000 in cash and the assumption of Reed’s share of Slicenhook’s debt. Carrie and Doug, however, are not certain that admitting Indie to the partnership is such a good idea. They want at least to consider having Slicenhook liquidate Reed’s interest on January 1, 2016. As of January 1, 2016, Slicenhook has the following assets:

Carrie and Doug propose that Slicenhook distribute the following to Reed in complete liquidation of his partnership interest:

Slicenhook has not purchased or sold any equipment since its original purchase just after formation.

a. Determine each partner’s recognized gain or loss upon formation of Slicenhook.
b. What is each partner’s initial tax basis in Slicenhook on January 2, 2014?
c. Prepare Slicenhook’s opening tax basis balance sheet as of January 2, 2014.
d. Using the operating results, what are Slicenhook’s ordinary income and separately stated items for 2014 and 2015? What amount of Slicenhook’s income for each period would each of the partner’s receive?
e. Using the information provided, prepare Slicenhook’s page 1 and Schedule K to be included with its Form 1065 for 2014. Also, prepare a Schedule K-1 for Carrie.
f. What are Carrie’s, Reed’s, and Doug’s bases in their partnership interest at the end of 2014 and 2015?
g. If Reed sells his interest in Slicenhook to Indie Ruff, what is the amount and character of his recognized gain or loss? What is Indie’s basis in the partnership interest?
h. What is Indie’s inside basis in Slicenhook? What effect would a §754 election have on Indie’s inside basis?
i. If Slicenhook distributes the assets proposed by Carrie and Doug in complete liquidation of Reed’s partnership interest, what is the amount and character of Reed’s recognized gain or loss? What is Reed’s basis in the distributed assets?
j. Compare and contrast Reed’s options for terminating his partnership interest. Assume that Reed’s marginal tax rate is 35 percent, and his capital gains rate is 15 percent.