ch10 HW ans

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Ch. 10 Answers to HW

11. a. A partner‟s basis in the partnership interest must be adjusted in the order shown inFigure 10.3: income items and contributions first increase basis, then basis isreduced by distributions from the partnership. Finally, losses may be deductedunder § 704(d) to the extent of any remaining basis. However, this allowed loss

may be further limited under the at-risk and passive loss rules.

b. In Brad‟s case, the $20,000 distribution reduces his basis in the partnershipinterest to $0 and Brad must recognize a $5,000 gain (probably a capital gain) inthe amount of the distribution that exceeds his $15,000 basis.

c. Since his basis is reduced to $0, none of the loss can be deducted. The full$10,000 is suspended under § 704(d) and must be carried forward until Brad hasadequate basis to absorb the loss.

d. If the partnership can make the distribution at the beginning of the following taxyear, Brad could deduct the loss in the current year. The partnership expects toreport earnings in f uture years, so Brad‟s share of that income would increase his

basis before the cash is distributed, and he will probably not be required to reporta capital gain on the distribution.

Alternatively, the partnership could incur additional (short-term) debt at the endof the year. This approach would be treated as a contribution of capital thatincreases Brad‟s basis in his partnership interest. With adequate basis, the cashcould be distributed without gain recognition, and the losses would be fullydeductible.

Figure 10.3 and Examples 28, 29, 37, and 38

14. a. Under § 721, neither the partnership nor the partners recognizes any gain onformation of the entity.

b. Chip will take a cash basis of $200,000 in his partnership interest.

c. Marty will take a substituted basis of $100,000 in his partnership interest($100,000 basis in the property contributed to the entity).

d. The partnership will take a carryover basis in the assets it receives ($200,000basis in cash, and $100,000 basis in property).

Example 14

16. a. Carol realizes a gain of $20,000 on contribution of the land. Connie realizes a

gain of $60,000 on contribution of the equipment. The partnership realizes a gainequal to the value of the property it receives (it has a $0 basis in the partnershipinterests it issues).

b. Under § 721, neither the partnership nor either of the partners recognizes any gainon formation of the entity. Example 8

c. Carol will take a substituted basis of $70,000 in her partnership interest ($30,000cash plus $40,000 basis in land). Connie will take a substituted basis of $30,000in her partnership interest ($30,000 basis in the equipment). Example 14

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d. The partnership will take a carryover basis in all the assets it receives ($30,000basis in cash, $40,000 basis in land, and $30,000 basis in equipment). p. 10-12

e. The partners‟ outside bases in their partnership interests total $100,000: Carol‟sbasis of $70,000 plus Connie‟s basis of $30,000. This is the same as the partnership‟s basis in assets of $100,000 ($30,000 cash plus $40,000 land plus

$30,000 equipment). p. 10-14f. The partnership will „„step into Connie‟s shoes” in determining its depreciation

expense. It will use the remaining depreciable life and the same depreciation ratesConnie would have used. p. 10-12

27. a. Assuming that Erica‟s capital account reflects an accurate number for basispurposes, the calculation is as follows:

Capital account balance, beginning of year $120,000Share of EG‟s debt ($80,000 × 1/2) 40,000Erica‟s basis, beginning of year $160,000

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b. Capital account balance, beginning of year $120,000

Add:Taxable income $70,000Tax-exempt interest income 1,000

§ 1231 gain 2,000Long-term capital gain 500 73,500$193,500

Less:Short-term capital loss $ 1,500Political contribution 500Charitable contribution 1,000Payment of Erica‟s medical expenses 4,000Cash distribution to Erica 10,000

(17,000)$176,500

Plus: Share of EG‟s debt ($100,000 × 1/2) 50,000Erica‟s basis, end of year $226,500

Note that payment of Erica‟s medical costs is treated as a distribution to Erica.Also note that the political contribution decreases her basis even though Ericacannot deduct the expense.

Examples 34 and 35, and Figure 10.3

Research Problem 3

a. Either June 30 or December 31 would be an acceptable year-end.Under § 706(b)(1), the LLC (partnership) required taxable year is the first of thefollowing that apply. The majority interest taxable year.

The same taxable year as all of the principal (5% or greater interest) partners. The year determined under the “least aggregate deferral” rules, as explained in the regulations.The majority interest taxable year does not apply since neither of the LLC members has amajority interest (>50%) in the profits and capital of the LLC. (§ 704(b)(4)(A))Both Cameron and Totco are principal partners (5% or greater interests) in the CT, LLC,but since both members do not have the same taxable year, the principal partner rule doesnot apply.Therefore, CT, LLC must choose the taxable year that provides for the least aggregatedeferral of income. To determine the required tax year of an LLC (partnership) underthis method, perform the following steps.

Select one partner's tax year as a test year. Calculate the number of months from the end of the test year to the next yearendfor each partner (i.e., determine the number of deferral months for eachpartner). Multiply the number of income deferral months for each partner by eachpartner's profit percent. Add the products to determine the aggregate number of deferral months for the

8/2/2019 ch10 HW ans


test year. Repeat the process until each partner's tax year has been used as a test year. Compare the aggregate number of deferral months for each test year. The test year that has the smallest number of aggregate deferral months is therequired tax year.

TEST FOR 12/31 YEAR-END (Cameron's year-end)Months of Partner Year Ends Profit Interest Deferral ProductCameron 12/31 1/2 × 0 = 0.00Totco, Inc. 6/30 1/2 × 6 = 3.00Aggregate number of deferral months 3.0010-48 2010 Annual Edition/Instructor’s Guide with Lecture Notes © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

TEST FOR 6/30 YEAR-END (Totco, Inc.'s year-end)Months of Partner Year Ends Profit Interest Deferral ProductCameron 12/31 1/2 × 6 = 3.00Totco, Inc. 6/30 1/2 × 0 = 0.00Aggregate number of deferral months 3.00Under the least aggregate deferral test, both a June 30 and December 31 year end providefor the same amount of deferral. Under regulations, if this calculation results in twotaxable years with the same least aggregate deferral, the partnership may select either oneof these taxable years as its taxable year. (Reg. § 1.706-1(b)(3)(i)).b. If the partnership originally selected a June 30 taxable year, the year end of the LLC willremain June 30. The majority interest rule will now apply and Totco, Inc., a June 30fiscal year taxpayer will own a majority (75%) interest in the LLC.If the partnership originally selected a December 31 taxable year, the taxable year of theLLC must change to June 30. Under Reg. § 1.706-1(b)(8)(i)(A), a partnership has

automatic approval from the IRS to make this change. If the year end changes againunder the majority interest rule (e.g., if Totco, Inc. sells a portion of its interest to acalendar-year individual), the LLC will not be required to change its year again withintwo years after the initial change (Reg. § 1.706-1(b)(8)(i)(C)).Under Reg. § 1.706-1(b)(9), the December 31 partnership taxable year could be retained only if the LLC could get approval from the IRS for a “natural business year” or by making a § 444 election. The problem states that CT does not have a natural business year. A § 444 election isnot available since the 6-month deferral from the required taxable year is greater than themaximum 3-month deferral permitted under § 444. [§ 444(b)(2)].The change from a December 31 taxable year to a June 30 taxable year will be madeunder the provisions of Rev. Proc. 2006-46 (2006-45 IRB 859, 10/18/06).

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ch10 HW ans