Formation of Partnerships - Oelerich & Associates · I. Contributions of Property to a Partnership...

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17 - Formation of Partnerships 1

Page 333-359

I. Contributions of Propertyto a Partnership

The basics of partnership property contribution


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While there were gains and losses realized by the partner no recognition will occur at the time of the property contribution IRC 721(a)

Calvin WoodrowFMV Basis FMV Basis

Cash 50,000 50,000Trucks 150,000 80,000Tools 5,000 0Real Estate 155,000 105,000Pre-ContributionGain

$75,000 $50,000


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F. Document the capital contributions – create file worksheet

617 - Formation of Partnerships

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II. Planning Opportunities –Triggering Gain or Loss

Be a planner not a box filler:Trigger gain if: Losses that could be offset during the year. Basis increases may be create tax advantages

in the futureTrigger losses if (This requires a 50% or less interest): Contributed property that has lost value over

time. Change in character of property


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III. Book Capital Accounts

A. This represents the BOOK records of the partnership

B. Maintained to comply with safe harbor rules of Reg. § 1.704-1(b) and used only by those partnerships required to deal with special allocations

C. Recorded at FMVD. Track ECONOMIC REALITY

Most partnerships are not required to maintain


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IV. Tax Capital Accounts


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V. Other Capital Account Considerations (Excluding Debt)

B. Maintenance of the Capital Accounts

1. No assignment made by the code, regulations or even court cases

2. Identify the responsibilities as provided by partnership agreement but disclose in the engagement agreement


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C. The tax basis on the 1065 does not yield the partners basis in all cases

Chapter 17: Partnership (or LLC) Operations

10401065



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D. No balance sheet, no books what do we do?

Look at Regulation § 1.705-1(b)

Compute the partnership’s inside basis in all assets

Multiply that result by the partner’s percentage

THE RESULT IS AN ESTIMATE


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How does the partner deal with the limitations and cost basis of their interest.

Must have been NO special allocations


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A testament to why balance sheets should be kept

Sherry FredTax Basis 50% 50%

Cash $25,000 $12,500 $12,500Other Assets $60,000 $30,000 $30,000Total $85,000 $42,500 $42,500

Sale to John $25,000Loss on Sale -$17,500


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VII. Holding Period

D. A partner’s holding period will depend on the nature and character of asset contributed based on:

Inventory & Cash / FMV of Assets = S/TSection 1231 / FMV of Assets = L/TGain based on partners outside basis


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X. Determining the Availability of Suspended Losses

Add suspended losses to the contributing partners basis BUT they are not added to the basis in the hands of the partnership


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XIII. Tax Treatment of Service Partner

The letter of intent and cash was not created solely for the partnership however the design was


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The IRC 83(b) election – Some recent changes

T.D. 9779 Reg. § 1.83-2 – Effective date 1/1/2016 A copy of the election must be submitted to the IRS office

where the taxpayer’s return would be filed The election is no longer required to be attached to the

taxpayer’s return However, the election statement must be maintained by the

taxpayer during the statutory period



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Have your cake and eat it too – Services provided to partnership do not increase basis without a corresponding income recognition, i.e. there was no money.



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XIV. Transfers of Property to an Investment Company Partnership


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XV. Contributing AssetsSubject to Liabilities

Contributions of liabilities in excess of basis

• A debt relief issue and a debt assumption issue

• If net debt relief > basis taxable


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Simple Math Basis – Debt Relief + Debt Assumption = Partner’s Basis in Contributed Property – Example Detail Following


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Simple Math

Woodrow’s INSIDE BASISBasis in WarehouseLess: Total Debt ReliefNet Inside Basis

Woodrow’s OUTSIDE BASISTax Capital (Inside Basis)Debt BasisNet Outside Basis

$105,000$100,000

$5,000

$5,000$50,000$55,000

+ Basis– Debt Relief = Inside Basis

+ Inside Basis+ Debt Assumption = Outside Basis


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What happens when net debtrelief exceeds the partner’s basisin the contributed property?

A taxable contribution and a ZERO tax basis


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Not so simple math with debt in excess of basis

Woodrow’s INSIDE BASISBasis in WarehouseLess: Total Debt ReliefNet Inside Basis

Woodrow’s OUTSIDE BASISTax Capital (Inside Basis)Debt BasisNet Outside Basis

$20,000 $100,000 ($80,000)

($80,000)$50,000

($30,000)

+ Basis– Debt Relief = Inside Basis but not less than ZERO

+ Inside Basis+ Debt Assumption = Outside Basis

Taxable Amount $30,000


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With Woodrow’s Taxable Event then the Partnership will increase the inside basis of the contributed property.

Woodrow’s capital account $-30,000Woodrow’s share of debt $30,000


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XVI. Character of Contributed Property

The possible tax trap not considered:


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XVI. Character of Contributed Property

C. The tax outcome of a future sale for a period of five years will be dependent in some cases of the nature of the asset in the hands of the contributor.

Inventory will be ordinary Capital Loss will be capital

The ordinary treatment of inventory will be for the entire gain incurred by the partnership

The capital loss will be to the extent unrealized by the contributor at the time of transfer


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XVII. Contributing Appreciated or Depreciated Property

B. Recapture on sale by the partnership must be allocated in a manner that recognizes Basis versus FMV on contribution

C. Built in loss property1. The built in loss is used solely to determine

allocation on sale2. The FMV at the time of transfer is the basis in

the hands of the partnership


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IRC 704c–Pre-Contribution Gain/Loss-The Basics

Why – to balance the differences between the INSIDE BASIS (aka tax basis) and BOOK CAPITAL (FMV) or property contributed to a partnership

TAX FMV

XVIII. Contribution of Property with Built in Gain or Loss


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A. Requires the allocation of gains or losses to bring TAX and BOOK into sync

1. Over time differences will disappear

2. “Gain/Loss” is allocated to contributing partner

B. IRC 704(c) meant to “prevent” the shifting of tax consequences among partners



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C. Method of allocation

1. The Traditional Method Reg. § 1.704-3(b) –Income to the partner with the built in gain

2. The Traditional Method with curative allocations Reg. § 1.704-3(c) – Income to the partner with the built in gain plus deductions to the other partners

3. The Remedial Allocation Method Reg. § 1.704-3(d) – Create Depreciation and Offsetting Income Allocations to cure


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704(c) Gain


Page 348-349XVIII. Contribution of Property with

Built in Gain or Loss

XIX. Relief from 704(c) forSmall Disparities

Relief for small disparities –you can ignore it

Book versus adjusted basis variance is not greater than 15% for any tax year AND

The gross amount of variance is not greater than $20,000


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XIX. Allocations Using the Traditional Method Reg. § 1.704-3(b)

How can we “cure” built in gain under 704(c)?

Traditional method – Gain or losses are allocated to “contributing” partner upon taxable distribution of property.


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XX. Allocations Using the Traditional Method Reg. § 1.704-3(b)


0

XX. Allocations Using the Traditional Method Reg. § 1.704-3(b)

Book (FMV) Tax (Inside)

Carol Bob Carol Bob

Cash 100,000 100,000

Land 100,000 60,000

Basis 100,000 100,000 100,000 60,000

Land Sale Gain

Basis

10,000 10,000 10,000 10,00040,000

110,000 110,000 110,000 110,000


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Chapter 17: Formation17 - Formation of Partnerships 51

Page 353XX. Allocations Using the Traditional

Method Reg. § 1.704-3(b)

Chapter 17: Formation

Book TaxCarol Bob Carol Bob

Cash/Equip 100,000 100,000 100,000 180,000

Accum Depr -128,160

Remaining Basis 100,000 100,000 100,000 51,840

Year 1Spec Allocated

Remaining Basis

Year 2Spec Allocated

Remaining Basis

Year 3Spec AllocatedRemaining Basis

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20,000 20,00020,000 736

80,000 80,000 80,000 51,10420,000 20,000

20,000 736

60,000 60,000 60,000 50,36810,000 10,000

10,000 368

50,000 50,000 50,000 50,00017 - Formation of Partnerships 52

XXI. Allocations Using the Traditional Method with Curative Allocations

Reg. § 1.704-3(c)

Traditional method with curative allocations –Allocates income, gains, losses and deductions in a “reasonable” manner to eliminate the differential

Subject to the ceiling rules

Examples in text


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XXII. Allocations Using the RemedialAllocation Method Reg. § 1.704-3(d)

Remedial Allocation Method – Creates artificial deductions/income to be “allocated” amongst partners

Relieves the issue of the ceiling rule that restricts the traditional method with curative allocations


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Formation of Partnerships - Oelerich & Associates · I. Contributions of Property to a Partnership...

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