Tax Chapter 20 No Homework Forming and Operating Partnerships

Chapter 20 - Forming and Operating Partnerships
Chapter 20
Forming and Operating Partnerships
SOLUTIONS MANUAL
Discussion Questions
1. [LO 1] What is a flow-through entity, and what effect does this designation have on
how business entities and their owners are taxed?
Flow-through entities are entities that are not taxed on the entity level;
rather, these entities are taxed on the owner’s level. These types of en-
tities conduct a regular business; however, the income earned and de-
ductions allowed are passed to the owners of these flow-through enti-
ties, and the owners are taxed on the amount allocated to them. Thus,
flow-through entities provide a way for income and deductions to be
taxed only once instead of twice.
2. [LO 1] What types of business entities are taxed as flow-through entities?

The two main business entities that are taxed as flow-through entities
are partnerships and S corporations. Partnerships are taxed under Sub-
chapter K and consist of general partnerships, limited partnerships, and
limited liability companies (LLC). S corporations are taxed under Sub-
chapter S. Both these types of business entities are treated as flow-
through entities and are taxed accordingly.
3. [LO 1] Compare and contrast the aggregate and entity concepts for taxing partnerships and
their partners.
The aggregate concept treats partnerships more align with an individual.
Each partnership is viewed as an aggregation of each partner’s separate
interest in the assets and liabilities of the partnership. For example,
each partner is proportioned and taxed on a certain amount of income
the partnership creates. The partnership, as a whole, is never taxed.
The entity concept treats partnerships more align with a corporation.

Each partnership is an entity separate from its partners. For example,
the partnership decides on which tax method to use and which tax elec-
tions to make, not the partners individually.
4. [LO 2] What is a partnership interest, and what specific economic rights or entitlements
are included with it?
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A partnership interest is an equity interest in a partnership. This interest

is created through a transfer or sale of cash, property, or services in ex-
change for an equity interest in the partnership. A partnership interest
gives each partner certain rights or entitlements. The two main eco-
nomic rights are a capital interest and profit interest in the partnership.
A capital interest is the right for a partner to receive a share of the part-
nership assets during liquidation. A profit interest is the right or obliga-
tion for a partner to receive a share of the future income or losses of the
partnership.
5. [LO 2] What is the rationale for requiring partners to defer most gains and all losses when
they contribute property to a partnership?
The rationale for requiring partners to defer most gains and losses when
contributing property to a partnership is twofold. First, the IRS desires
that entrepreneurs have a way to start their own business without hav-
ing to pay any taxes upfront. Second, the partners are considered still
owning the property they have contributed to the partnership. While
they don’t own the property outright, each partner has a small percent-
age of the property contributed in her/his partnership interest she/he ex-
changed for. This second reasoning helps further support the idea that
partnerships follow the aggregate concept.
6. [LO 2] Under what circumstances is it possible for partners to recognize gain when con-
tributing property to partnerships?
Partners have the potential of recognizing gain on the contribution of
property when the property contributed is secured by debt. In determin-
ing whether gain must be recognized, the partner must assess the cash
deemed to have received from the partnership distribution compared
with the tax basis of the partner’s partnership interest prior to the
deemed distribution. If the cash deemed to have received exceeds the
tax basis, then a gain must be recognized. This circumstance occurs
due to the negative basis created for the partner, which is not allowed
under partnership tax law.
7. [LO 2] What are inside basis and outside basis, and why are they relevant for taxing
partnerships and partners?
An inside basis, in relation to partnerships, is the basis the partnership
takes in the assets that the partnership holds. An outside basis, in rela-
tion to partnerships, is the tax basis each partner has in the partnership.
The inside basis is necessary to compute the gain/loss recognized on all
property sold by the partnership. The outside basis is necessary to com-
pute the gain/loss recognized on the partnership interest when sold. For
tax purposes, the inside basis is similar to the basis the partner had in
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the property prior to contribution. On the other hand, the outside basis
corresponds not only to the contributed property, but also to the debt
and income/losses of the partnership.
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8. [LO 2] What is recourse and nonrecourse debt, and how is each generally allocated to part-
ners?
Recourse debt is debt for which partners are considered to have an eco-
nomic risk of loss. This type of debt partners are legally liable for and
must satisfy personally if the partnership cannot. An example of re-
course debt is accounts payable. Nonrecourse debt is debt for which no
partners are considered to have an economic risk of loss in. This is a
debt for which partners are not legally liable for. An example of nonre-
course debt is a mortgage.
In regards to a partnership’s debt, recourse debt is allocated to those

partners that have the ultimate responsibility of paying the debt. The
debt is allocated to the partners that have an economic risk of loss. On
the other hand, nonrecourse debt is allocated to all the partners accord-
ing to the profit sharing ratios. Despite the partners not being legally li-
able for this debt, the debt is allocated proportionately to adjust the out-
side basis of each partner.
9. [LO 2] How does the amount of debt allocated to a partner affect the amount of gain a part-
ner recognizes when contributing property secured by debt?
A partner that contributes property secured by debt is not only con-
tributing the property to the partnership but also the debt. In calculat-
ing the outside basis of the partner, the partner must take her/his tax
basis in the property and decrease her/his basis by the amount of the
property’s debt. Next, the property’s debt is allocated to each partner
according to who is ultimately responsible for it or by each partner’s
profit-sharing ratio. If the partner is not allocated enough debt, the part-
ner’s outside basis will become negative and a gain must be recognized.
Thus, a partner can only avoid gain by obtaining enough of the partner-
ship debt to keep her/his basis at least above zero.
10. [LO 2] What is a tax-basis capital account, and what type of tax-related information does it
provide?
A tax-basis capital account is an equity account that is created for each
partner of the partnership. This account is measured using the tax ac-
counting rules. The account reflects tax basis of any capital contribu-
tions (i.e., property and cash), capital distributions, and future earnings
and losses allocated to that partner. Additionally, a tax-basis capital ac-
count can provide more tax-related information for each partner. For in-
stance, each partner’s share of inside basis of the partnership’s assets
can be calculated by adding the partner’s share of debt to her/his capital
account. Furthermore, if a partner acquires her/his interests by con-
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tributing property tax-free, then the partner’s outside basis will be equal
to that partner’s share of partnership inside basis.
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11. [LO 2] Distinguish between a capital interest and a profits interest, and explain how part-
ners and partnerships treat when exchanging them for services provided.
A partnership interest can be broken down into two distinct rights: (1)
capital interest and (2) profits interest. To become a partner in a part-
nership, you will receive at least one of these rights. A capital interest is
the right to receive a share of the partnership assets at liquidation. A
profits interest is the right to share in the future earnings and losses of
the partnership. While these rights are given to most partners that con-
tribute cash or property, special rules exist when these rights are given
to partners in exchange for services.
When a partner receives a capital interest in exchange for services ren-

dered to the partnership, the partner must treat the liquidation value of
the capital interest as ordinary income. Further, the tax basis for the
partner will be equivalent to the amount of ordinary income recognized.
The holding period for this tax basis will begin on the date the capital in-
terest is received. From the partnership’s perspective, the partnership
can deduct or capitalize the value of the capital interest depending upon
the type of services rendered. This is determined on a fact and circum-
stance basis. Additionally, the amount deducted by the partnership is
allocated to the non-service partners as consideration for effectively
transferring a portion of their capital interest to the service partner.
When a partner receives a profit interest in exchange for services ren-

dered to the partnership, the partner has no immediate tax impact be-
cause they have no liquidation value at the time they are received.
Thus, the non-service partners will not receive any deductions for the
additional partner to the partnership. As the partnership makes future
profits and losses, the service partner will be allocated her/his portion of
these losses according to the profit sharing ratios. The debt allocated to
non-service partners must also be redistributed with the additional ser-
vice partner receiving her/his portion of debt. Therefore, the tax basis of
a service partner with only a profit interest will either be zero or the por-
tion of debt the partner is allocated.
12. [LO 2] How do partners who purchase a partnership interest determine the tax basis and
holding period of their partnership interests?
When a partner purchases a partnership interest, the initial tax basis for
the partner is a determined by taking the cost basis of the interest the
partner purchased and adding to this basis any debt allocated to the
partner’s interest. The holding period for this purchased interest will be-
gin on the date that the partner purchased the partnership interest.
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13. [LO 3] Why do you think partnerships, rather than the individual partners, are responsible
for making most of the tax elections related to the operation of the partnership?
The responsibility for the partnership, not the partners, to make the ma-
jority of tax elections regarding the operation of the partnership is
twofold. First, partnerships can consist of many different partners rang-
ing from two to hundreds. The hassle to obtain every partner’s approval
on what elections to make would be very time consuming. The costs
would more than likely outweigh the benefits in performing this function.
Second, in many partnerships only a few partners are actively involved
in the management of the partnership. The limited partners have own-
ership to obtain a tax advantage on their own personal returns. Thus,
the entity concept would appear more reasonable when dealing with the
actual operations of the partnership.
14. [LO 3] If a partner with a taxable year-end of December 31 is in a partnership with a March
31 taxable year-end, how many months of deferral will the partner receive? Why?
A partner with a calendar year end will receive nine months of deferral
in her/his partnership interest that has a March 31 year end. A partner
must report the income or loss of the partnership not at the partner’s
year end but at the partnership’s year end. Thus, the first year of the
partnership will be reported by the partner on her/his second return
which includes the partnership’s year end.
15. [LO 3] In what situation will there be a common year-end for the principal partners when
there is no majority interest taxable year?
The principal partner test states that the required tax year is the taxable
year all the principal partners have in common. A principal partner is a
partner that owns at least 5 percent interest in the partnership profits
and capital. For the principal partner test to pass and not the majority
interest test, the partnership must consists of numerous partners that
(1) own less than 5 percent profit and capital interest and (2) have a va-
riety of fiscal year ends. For example, if four partners with a calendar
year end owned 10 percent and 20 additional partners with differing fis-
cal year ends owned less than 5 percent, then the majority test would
not pass, but the principal partners test would.
16. [LO 3] Explain the least aggregate deferral test for determining a partnership’s year end
and discuss when it applies.
The least aggregate deferral test is the last resort test that a partnership
must follow when figuring out the partnership year end. The first test is
the majority interest test. The second test is the principal partners test.
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If these two tests don’t apply, along with the exception to elect an alter-
native year end, then the least aggregate deferral test goes into effect.
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The least aggregate deferral test selects the tax year which provides the
partner group as a whole the smallest amount of aggregate tax deferral.
This is calculated by taking each partner’s months of deferral under the
potential tax year and weighting it with the partner’s profit interest per-
centage. Then, each partner’s weighted totals are summed up to come
up with an aggregate deferral number. The potential tax year that pro-
duces the smallest aggregate deferral must be the one chosen by the
partnership.
17. [LO 3] When are partnerships eligible to use the cash method of accounting?
A partnership is eligible to use the cash method of accounting unless the
partnership has average gross receipts over the past three taxable years
greater than $5 million and has a corporate partner. Under the tax ac-
counting laws, a partnership must use the accrual method of accounting
with a corporate partner, unless the above exception applies.
18. [LO 4] What is a partnership’s ordinary business income (loss) and how is it calculated?
Through the course of business, partnerships create income or losses.
Some of these items are considered to affect a specific partner or groups
of partners differently. Thus, these separately-stated items must be re-
ported on a partner-by-partner basis. Then, after adjusting the partner-
ship’s business income (loss) for these separately-stated items, the part-
nership reports the remaining amount of business income (loss) to ordi-
nary business income (loss). The total amount will be allocated to each
partner according to the special allocation rules agreed upon or else
based upon the profit sharing ratios of the partnership.
19. [LO 4] What are some common separately stated items, and why must they be separately
stated to the partners?
Separately-stated items must be taken out of ordinary income (loss) be-
cause these items either (1) relate only to a specific partner in the part-
nership or (2) the item is taxed differently for each partner depending
upon the entity of the partner and the partner’s current tax situation.
The following is a list of items that are considered to be separately stat-
ed on a partnership return.
1. Short-term capital gains (losses)

2. Long-term capital gains (losses)
3. Section 1231 gains (losses)
4. Charitable contributions
5. Dividends
6. Interest income
7. Guaranteed payments
8. Net earnings (losses) from self-employment
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9. Tax-exempt income
10. Net rental real estate income (loss)
11. Investment interest expense
12. Section 179 deductions
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20. [LO 4] Is the character of partnership income/gains and expenses/losses determined at the
partnership or partner level? Why?
In keeping with the entity concept, the character of all income/gains and
expenses/losses is determined at the partnership level. Despite the
chance that specific items would change character depending upon the
partner who holds them, the IRS has decided to unify the character of all
items by looking at the character from the partnership’s perspective.
Thus, partnerships are required to file a 1065 return along with all part-
ners’ K-1s to help audit the amounts and character that show up on the
individual partner’s return.
21. [LO 4] What are guaranteed payments and how do partnerships and partners treat them for
income and self-employment tax purposes?
Guaranteed payments are similar to cash salary payments for services
provided. The idea behind a guaranteed payment is for a partner to re-
ceive a fixed amount of income no matter the profit (loss) for the part-
nership’s taxable year. Thus, on the partnership level, they are treated
like a salary payment to an unrelated party. The partnership deducts
the guaranteed payment in computing the partnership’s ordinary busi-
ness income (loss).
On the partner level, the partner that receives a guaranteed payment

must account for the guaranteed payment as a separately-stated item
that is taxed as ordinary income. Further, the partner must include the
amount of the guaranteed payment in computing self-employment in-
come for tax purposes. This amount is included no matter if the partner
is a general partner, limited partner, or LLC member.
22. [LO 4] How do general and limited partners treat their share of ordinary business income
for self-employment tax purposes?
In determining how different partners treat their share of ordinary busi-
ness income, the IRS assesses the involvement the partner has in the
partnership. General partners are considered to be actively involved in
the management of the partnership. Thus, the general partner’s share
of ordinary business income is treated as trade or business income and
is subject to self-employment tax. Conversely, limited partners are gen-
erally not actively involved with managing the partnership. The limited
partner’s share of ordinary business income is treated as investment in-
come and not subject to self-employment tax. Both types of partners
must treat guaranteed payments as income relating to self-employment;
however, the ordinary business income depends on the type of partner.
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23. [LO 4] What challenges do LLCs face when deciding whether to treat their members’
shares of ordinary business income as self-employment income?
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Due to the lack of authoritative ruling that exists for LLCs, members
must decide on their own whether to include ordinary business income
as self-employment income or not. A proposed regulation gave us clari-
ty on this matter; however, the regulation was withdrawn. Members of
an LLC should still review this proposed regulation to understand the
stance the IRS is trying to take and whether they will take an aggressive
or conservative stance for their specific situation.
The proposed regulation helped clarify that if an LLC member is involved

in the operations of the LLC, the member should treat the ordinary busi-
ness income as self-employment income. The regulation listed the fol-
lowing three criteria that would demonstrate active involvement in the
LLC: (1) personally liable for the debt of the LLC as an LLC member, (2)
authority to contract on behalf of the LLC, or (3) participate in more than
500 hours in the LLC’s trade or business during the taxable year. If any
one of these requirements is met, then the LLC member would be more
associated as a general partner and should more than likely account for
the ordinary business income as self-employment income.
24. [LO 4] How much flexibility do partnerships have in allocating partnership items to part-
ners?
Partnerships have a great deal of flexibility in determining how to allo-
cate partnership items to partners, both separately-stated and non-sep-
arately stated items. The determining factors must be (1) the partners
agree upon the allocations and (2) the allocations have substantial eco-
nomic effect. The second factor is put into place to make sure the allo-
cations are being accomplished for a business objective and not just to
reduce or avoid taxes. While both of these items need to be met for a
special allocation of a partnership item, certain items have mandatory
allocations to specific partners. For example, contributed property built-
in gain (loss) must be allocated to the partner who contributed the prop-
erty when the property is sold. Any additional gain (loss) will be allocat-
ed according to the partnership agreement. Overall, if the partnership
has no mandatory allocations or does not specify and meet the require-
ments for special allocations, the partnership will allocate according to
the capital or profit interest.
25. [LO4] What are the basic tax-filing requirements imposed on partnerships?
While a partnership does not pay taxes, the IRS still requires all partner-
ships to file an information return to the IRS – Form 1065 (U.S. Return of
Partnership Income). This form must be filed by the 15th day of the 4th
month of the partnership’s year end. For calendar year end partner-
ships, the form must be filed by April 15th. An extension is available to
file by the due date of the original return and provides the partnership
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an additional five months to file Form 1065. The extension must be filed
on Form 7004.
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The tax return that must be filed by all partnerships consists of a de-
tailed calculation of the partnerships ordinary business income (loss) on
page 1 of Form 1065. On page 3 of Form 1065, Schedule K must be
filled out which lists the ordinary business income (loss) along with any
separately-stated items. This schedule is an aggregate of each partner’s
share of items both separately-stated and non-separately stated. In ad-
dition, each partner’s proportion of the above items is reported on a
Schedule K-1. A Schedule K-1 for every partner must be filed with Form
1065, and each individual partner will receive her/his own Schedule K-1
from the partnership.
26. [LO 5] In what situations do partners need to know the tax basis in their partnership inter-
ests?
Partners should always keep track of the tax basis in their partnership in-
terest; however, certain situations require partners to actually know
their tax basis. These situations include when a partner sells her/his
partnership interest or when a partner receives a distribution from the
partnership. The main reasoning is to help the partner figure out the
amount of gain which s/he most report on her/his current tax return.
27. [LO 5] Why does a partner’s tax basis in her partnership need to be adjusted annually?
A partner’s tax basis needs to be adjusted annually for the following
three reasons. First, a partner does not want to double count any in-
come/gain from the partnership when she/he sells her/his partnership in-
terest or receive a distribution from the partnership. Second, the IRS
does not want partners to double count any expenses/losses from the
partnership in a similar situation from above. Last, partners want to
make sure they adjust for tax-exempt income and non-deductible ex-
penses, so these items will not ultimately be taxed or deducted at the
time of selling a partnership interest or receiving a distribution from the
partnership.
28. [LO 5] What items will increase a partner’s basis in her partnership interest?
The following items will increase a partner’s basis and must be adjusted
for on an annual basis in the order given.
1. Actual and deemed cash contributions to the partnership
2. Partner’s share of ordinary business income
3. Partner’s share of separately-stated income/gain items and
4. Partner’s share of tax-exempt income
29. [LO 5] What items will decrease a partner’s basis in her partnership interest?
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The following items will decrease a partner’s basis and must be adjusted
for on an annual basis in the order given. These items will be adjusted
after all the increases to a partner’s basis have been taken into effect.
1. Actual and deemed cash distributions from the partnership
2. Partner’s share of non-deductible expenses (fines, penalties,
etc.)
3. Partner’s share of ordinary business losses and
4. Partner’s share of separately-stated expenses/loss items
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30. [LO 6] What hurdles (or limitations) must partners overcome before they can ultimately
deduct partnership losses on their tax returns?
While a partnership can create an ordinary business loss, the individual
partners potentially will not be able to deduct the entire amount in the
year of the loss. The partner must overcome three loss limitation rules
before the deduction is available. If the loss does not pass any of the
limitations, then the loss is suspended indefinitely under that specific
hurdle. The three loss limitations are (1) assessing the tax basis of the
partner, (2) evaluating the at-risk loss limitation, and (3) the passive ac-
tivity loss limitation.
First, a partner is not able to take any losses that exceed the tax basis of
the partner, the partner’s outside basis. This limitation prevents part-
ners from taking losses beyond their investment or basis in their part-
nership interests. Second, a partner cannot take any losses that exceed
the at-risk limit for the partner. The at-risk limit is generally the same as
the partner’s tax basis, except for the share of nonrecourse debt attrib-
utable to the partner. This limit still includes recourse debt and qualified
nonrecourse debt. Finally, losses cannot be taken if the loss exceeds the
amount of passive income reported by the partner. Passive losses, loss-
es from rental activities or limited partnerships, can only be offset with
passive gains.
31. [LO 6] What happens to partnership losses allocated to partners in excess of the tax basis in
their partnership interests?
Losses that are allocated to partners that exceed the partner’s tax basis
cannot be used during the current taxable year. The excess loss will be
suspended and carried forward indefinitely until the partner has suffi-
cient basis to utilize the losses. A partner would be able to increase
her/his tax basis by (1) making a capital contribution, (2) guaranteeing
more partnership debt, or (3) helping the partnership become more prof-
itable. Once the partner’s tax basis is positive, the losses previously
suspended can be used.
32. [LO 6] In what sense is the at-risk loss limitation rule more restrictive than the tax basis
loss limitation rule?
While the at-risk loss limitation and tax basis loss limitation are basically
the same, one difference exists between the two different hurdles a
partner must overcome when faced with losses. The at-risk loss limita-
tion only accounts for those items that the partner is at risk for. The ma-
jor item that is not included under the at-risk calculation but is included
in the tax basis is nonrecourse debt. As a note, qualified nonrecourse
debt is still considered to be part of the partner’s at-risk calculation.
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33. [LO 6] How do partners measure the amount they have at risk in the partnership?
A partner will measure her/his partnership at-risk amount by looking at
what items affect the partner’s economic risk of loss. In most cases,
items included in the at-risk amount would include cash contributed, tax
basis of property contributed, recourse debt, qualified nonrecourse debt,
and any other adjustments to the partner’s tax basis excluding nonre-
course debt. Nonrecourse debt is considered a part of the tax basis but
not a part of the at-risk basis since the partner does not have an eco-
nomic risk of loss for this type of debt.
34. [LO 6] In what order are the loss limitation rules applied to limit partner’s losses from part-
nerships?
The order of the hurdles a partner must pass for the loss limitation rules
are (1) tax basis loss limitation, (2) at-risk loss limitation, and (3) passive
activity loss limitation. As the losses exceed the limitation in each hur-
dle, the suspended losses will be carried forward indefinitely within each
group until enough basis or income is generated to cover these losses.
Once the loss has passed all three limitations, the partner can use the
loss as a deduction on her/his own personal return.
35. [LO 6] How do partners determine whether they are passive participants in partnerships
when applying the passive activity loss limitation rules?
According to the Code, a partner is considered to be a passive partici-
pant if the activity conducted is a trade or business and the partner does
not materially participate in the activity. The IRS has made it clear that
those participants in rental activities and limited partners within a part-
nership are automatically considered to be passive participants.
Further, regulations help clarify whether a partner would be considered a

material participant. If the partner meets any of the conditions below,
then the partner would be a material participant and the activity would
not be considered a passive activity to the partner.
1. The individual participates in the activity more than 500 hours dur-
ing the year.
2. The individual’s activity constitutes substantially all of the participa-
tion in such activity by individuals.
3. The individual participates more than 100 hours during the year and
the individual’s participation is not less than any other individual’s par-
ticipation in the activity.
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4. The activity qualifies as a “significant participation activity” (individ-

ual participates for more than 100 hours during the year) and the ag-
gregate of all other “significant participation activities” is greater than
500 hours for the year.
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5. The individual materially participated in the activity for any 5 of the

preceding 10 taxable years.
6. The activity involves personal services in health, law, accounting,
architecture, and so on, and the individual materially participated for
any three preceding years.
7. Taking into account all the facts and circumstances, the individual
participates on a regular, continuous, and substantial basis during the
year.
36. [LO 6] Under what circumstances can partners with passive losses from partnerships
deduct their passive losses?
A partner may deduct the passive losses she/he has generated from a
partnership under three circumstances. First, a passive loss is not de-
ductible until the taxpayer generates current year passive income in the
activity producing the loss. Second, a passive loss is not deductible until
the taxpayer generates current year passive income from another pas-
sive activity the taxpayer is involved with. Last, a passive loss will not
be deductible unless the taxpayer sells the activity that has produced
the passive loss. In this case, the taxpayer will report a gain or loss on
the sale and can use the passive loss to offset this or any other source of
income ( i.e., active income, portfolio income, or other passive income).
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Problems
37. [LO 2] Joseph contributed $22,000 in cash and equipment with a tax basis of $5,000 and a
fair market value of $11,000 to Berry Hill Partnership in exchange for a partnership inter-
est.
a. What is Joseph’s tax basis in his partnership interest?
b. What is Berry Hill’s basis in the equipment?
a. $27,000.
Joseph’s tax basis is considered to be his outside basis in the partner-
ship. The tax basis includes the $22,000 in cash and his original ba-
sis in the equipment, $5,000. Joseph’s holding period for his outside
basis would depend upon the holding period of the assets contrib-
uted. All capital or Section 1231 assets tacks onto the partnership in-
terest. All other property has a holding period from the date the part-
nership interest is acquired.
b. $5,000.
Berry Hill Partnership’s basis in the equipment is a carryover basis
from the partner who contributed the equipment. The basis in the
equipment plus the basis in the cash will give us Berry Hill Partner-
ship’s inside basis. The holding period for the equipment carries over
to the Berry Hill Partnership from Joseph.
38. [ LO 2] Lance contributed investment property worth $500,000, purchased three years ago
for $200,000 cash, to Cloud Peak LLC in exchange for an 85 percent profits and capital in-
terest in the LLC. Cloud Peak owes $300,000 to its suppliers but has no other debts.
a. What is Lance’s tax basis in his LLC interest?
b. What is Lance’s holding period in his interest?
c. What is Cloud Peak’s basis in the contributed property?
d. What is Cloud Peak’s holding period in the contributed property?
a. $455,000.
Lance’s basis in his LLC interest is made up of the $200,000 basis of
the investment property he transferred to the LLC and his $255,000
share of the LLC debt (85% x $300,000). Because LLC general debt
obligations are treated as nonrecourse debt, Lance’s profit sharing ra-
tio is used to allocate a portion of the LLC debt to him.
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b. Three years.
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Because Lance contributed a capital asset, the holding period of the

contributed assets “tacks onto” his partnership interest.
c. $200,000.
The LLC takes a carryover basis in the contributed property.
d. Three years.
The LLC inherits Lance’s holding period in the contributed property.
39. [ LO 2] Laurel contributed equipment worth $200,000, purchased 10 months ago (acquired
on January 31st) for $250,000 cash and used in her sole proprietorship, to Sand Creek LLC
in exchange for a 15 percent profits and capital interest in the LLC. Laurel agreed to guar-
antee all $15,000 of Sand Creek’s accounts payable but she did not guarantee any portion
of the $100,000 nonrecourse mortgage securing Sand Creek’s office building. Other than
the accounts payable and mortgage, Sand Creek does not owe any debts to other creditors.
a. What is Laurel’s initial tax basis in her LLC interest?
b. What is Laurel’s holding period in her interest?
c. What is Sand Creek’s initial basis in the contributed property?
d. What is Sand Creek’s holding period in the contributed property?
40. [LO 2] {Planning}Harry and Sally formed the Evergreen partnership by contributing the
following assets in exchange for a 50 percent capital and profits interest in the partnership:
Harry: Basis Fair Market Value

Cash $ 30,000 $ 30,000
Land 100,000 120,000
Totals $ 130,000 $ 150,000
Sally:
Equipment used in a business 200,000 150,000
Totals $ 200,000 $ 150,000
a. How much gain or loss will Harry recognize on the contribution?
b. How much gain or loss will Sally recognize on the contribution?
c. How could the transaction be structured a different way to get a better result for Sally?
d. What is Harry’s tax basis in his partnership interest?
20-24
e. What is Sally’s tax basis in her partnership interest?
f. What is Evergreen’s tax basis in its assets?
g. Prepare a tax basis balance sheet for the Evergreen partnership showing the tax
capital accounts for the partners.
a. $0.
Generally, partners recognize gain on property contributed to a part-
nership only when the cash they are deemed to receive from debt re-
lief exceeds their basis in the partnership prior to the deemed distri-
bution. Harry did not have any debt relief.
b. $0.
Partners may never recognize loss when property is contributed to a
partnership even when they are relieved of debt.
c. Sally should consider selling the property to the partnership rather

than contributing it. By selling the property, she could recognize the
$50,000 built-in loss on the equipment.
d. $130,000.
Harry’s basis in his partnership interest is simply the combined tax
basis in the cash and land he contributed to the partnership.
20-25
e. $200,000.
Sally’s basis in her partnership interest equals $200,000 basis in the
equipment she contributed.
f. $330,000.
The partnership’s basis in its assets equals the sum of the partners’
bases in the cash ($30,000), in the land ($100,000), and in the equip-
ment ($200,000).
g. The partnership’s tax basis balance sheet would appear as follows:
Evergreen Partnership
Tax Basis Balance Sheet
Tax Basis
Assets:
Cash $30,000
Equipment 200,000
Land 100,000
Totals $330,000
Capital:
Capital-Harry 130,000
Capital-Sally 200,000
Totals $330,000
41. [LO 2] Cosmo contributed land with a fair market value of $400,000 and a tax basis of
$90,000 to the Y Mountain partnership in exchange for a 25 percent profits and capital in-
terest in the partnership. The land is secured by $120,000 of nonrecourse debt. Other than
this nonrecourse debt, Y Mountain partnership does not have any debt.
a. How much gain will Cosmo recognize from the contribution?
b. What is Cosmo’s tax basis in his partnership interest?
a. $0.
As reflected in the table below, Cosmo does not recognize any gain
because the $120,000 of cash he is deemed to receive from debt re-
lief does not exceed his basis in Y Mountain prior to this deemed dis-
tribution.
20-26
Description Cosmo Explanation

(1) Basis in contributed $90,000
Land
(2) Nonrecourse mortgage $30,000Nonrecourse
in excess of basis in con- debt > basis is
tributed land allocated only
to Cosmo
(3) Remaining nonre- $22,50025% x
course mortgage [120,000 - (2)]
(4) Relief from mortgage ($120,000)
debt
Cosmo’s initial tax basis in $22,500(1) + (2) + (3)
Y Mountain + (4)
b. $22,500 as indicated in the table above.
42. [LO2] Maude, James, Harold and Jenny formed the High Horizon LLC by contributing the
following assets in exchange for 25 percent capital and profits interests in the LLC:
Maude:Basis Fair Market Value

Cash $ 20,000 $ 20,000
Land* 100,000 200,000
Totals $ 120,000 $ 220,000
*Nonrecourse debt secured by the land equals $160,000
James, Harold and Jenny each contributed $220,000 in cash.
a. How much gain or loss will Maude and the other members recognize?
b. What is Maude’s tax basis in her LLC interest?
c. What tax basis do James, Harold, and Jenny have in their LLC interests?
d. What is High Horizon’s tax basis in its assets?
e. Prepare a tax basis balance sheet for the High Horizon LLC showing the tax capi-
tal accounts for the members.
a.$0.
20-27
None of the partners recognize gain because their debt relief was not
in excess of their bases in their partnership interest prior to any debt
relief. See table below:
20-28
Description Maude Other Mem- Explanation

bers
Land
(2) Cash contributed $20,000 $220,000
(3) Nonrecourse mortgage $60,000 Nonrecourse
to Maude
(4) Remaining nonre- $25,000 $25,000 25% x
course mortgage [160,000 - (3)]
debt
Each member’s initial tax $45,000 $245,000 (1) + (2) + (3)
basis in the LLC + (4) + (5)
b.$45,000.
See table in part a. above.
c. $245,000 each.
d. $780,000.
High Horizon takes a $120,000 carryover basis in the assets Maude
contributes and a $660,000 in the total cash the other three mem-
bers contributed.
e. High Horizon’s tax basis balance sheet would appear as follows:
High Horizons, LLC

Tax Basis
Assets:
Cash $680,000
Land 100,000
Totals 780,000
20-29
Liabilities and Capital:

Mortgage debt 160,000
Capital-Maude (40,000)
Capital-James 220,000
Capital-Harold 220,000
Capital-Jenny 220,000
Totals 780,000
Note that the members’ tax capital accounts are equal to their bases
in the LLC interests less their individual shares of LLC debt.
43. [LO2] Kevan, Jerry, and Dave formed Albee LLC. Jerry and Dave each contributed
$245,000 in cash. Kevan contributed the following assets:
Kevan: Basis Fair Market Value

Cash $ 15,000 $ 15,000
Land* 120,000 230,000
Totals $ 135,000 $ 245,000
*Nonrecourse debt secured by the land equals $210,000
Each member received a one-third capital and profits interest in the LLC.
a. How much gain or loss will Jerry, Dave and Kevan recognize on the contribu-
tions?
b. What is Kevan’s tax basis in his LLC interest?
c. What tax basis do Jerry and Dave have in their LLC interests?
d. What is Albee LLC’s tax basis in its assets?
e. Prepare a tax basis balance sheet for the Albee LLC showing the tax capital ac-
counts for the members. What is Kevan’s share of the LLC’s inside basis?
f. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to
guarantee 33.33 percent of the debt and Jerry to guarantee the remaining 66.67 percent of
the debt when Albee LLC was formed, how much gain or loss will Kevan recognize?
g. If the lender holding the nonrecourse debt secured by Kevan’s land required Kevan to
guarantee 33.33 percent of the debt and Jerry to guarantee the remaining 66.67 percent of
the debt when Albee LLC was formed, what are the members’ tax bases in their LLC inter-
ests?
20-30
a. $0.
None of the partners recognize gain because their debt relief was not
in excess of their bases in their partnership interest prior to any debt
relief. See table below:
Description Kevan Other Mem- Explanation

bers
Land
(3) Nonrecourse mortgage $90,000 Nonrecourse
to Kevan
(4) Remaining nonre- $40,000 $40,000 33.3% x
course mortgage [$210,000 -
(3)]
debt
Each member’s initial tax $55,000 $285,000 (1) + (2) + (3)
basis in the LLC + (4)+ (5)
b.$55,000.
c. $285,000 each.
d. $625,000.
Albee, LLC takes a $135,000 carryover basis in the assets Kevan con-
tributes and a $490,000 in the total cash the other two members con-
tributed.
20-31
e. Albee, LLC’s tax basis balance sheet would appear as follows:
Albee , LLC
Tax Basis
Assets:
Cash $505,000
Land 120,000
Totals 625,000
Liabilities and Capital:
Mortgage debt 210,000
Capital-Kevan (75,000)
Capital-Jerry 245,000
Capital-Dave 245,000
Totals 625,000
Note that the members’ tax capital accounts are equal to their bases
in the LLC interests less their individual shares of LLC debt.
f. $5,000. See table below:
Description Kevan Jerry Dave Explanation

(1) Basis in contrib- $120,000
uted Land
(2) Cash contributed $15,000 $245,000 $245,000
(3) Mortgage Guar- $70,000 $140,000 $033.33% x
antee $210,000
for Kevan
and 66.67%
x $210,000
for Jerry
(4) Relief from mort- ($210,000)
gage debt
20-32
(5) Gain Recognized $5,000 $0 $0[(1)+ (2)+

(3) + (4)]
Each member’s ini- $0 $385,000 $245,000(1) + (2) +
tial tax basis in the (3)+ (4) +
LLC (5)
g. Kevan’s basis is $0, Jerry’s basis is $385,000, and Dave’s basis is

$245,000. See the table in part f. above.
44. [LO2] {Research} Jim has decided to contribute some equipment he previously used in his
sole proprietorship in exchange for a 10 percent profits and capital interest in Fast Chop-
pers LLC. Jim originally paid $200,000 cash for the equipment. Since then, the tax basis
in the equipment has been reduced to $100,000 because of tax depreciation, and the fair
market value of the equipment is now $150,000.
a. Must Jim recognize any of the potential § 1245 recapture when he contributes the ma-
chinery to Fast Choppers? {Hint: See § 1245(b)(3).}
b. What cost recovery method will Fast Choppers use to depreciate the machinery? {Hint:
See § 168(i)(7).}
c. If Fast Choppers were to immediately sell the equipment Jim contributed for $150,000,
how much gain would Jim recognize and what is its character? {Hint: See § 1245 and
704(c).}
a. According to Section 1245(b)(3), recapture potential on property con-

tributed to a partnership is only recognized to the extent any gain is
recognized from the contribution of property. Because Jim was not re-
lieved of any debt in the transaction, he will not recognize gain from
the contribution under Section 721. Therefore, Jim does not recog-
nize any of the Section 1245 recapture potential on the equipment at
the time of contribution.
b. According to Section 168(i)(7), a transferee partnership will step into

the shoes of the transferor partner for purposes of depreciating con-
tributed equipment. In this situation, Fast Choppers will continue to
depreciate the equipment using the same method instituted by Jim
over the remaining useful life of the equipment. In other words, the
annual depreciation calculation will proceed as if the property were
still held by Jim.
20-33
c. Under Section 704(c), all $50,000 of gain recognized from the sale of
the equipment would be allocated to Jim because this gain was built-
in at the time the equipment was contributed. Moreover, the Section
1245 recapture potential remains with the equipment after the contri-
bution; as a result, all $50,000 of gain recognized (the lesser of the
$50,000 gain recognized or the $100,000 depreciation taken) must
be characterized as Section 1245 recapture income.
45. [LO2] {Research} Ansel purchased raw land three years ago for $200,000 to hold as an in-
vestment. After watching the value of the land drop to $150,000, he decided to contribute
it to Mountainside Developers LLC in exchange for a 5 percent capital and profits interest.
Mountainside plans to develop the property and will treat it as inventory, like all of the oth-
er real estate it holds.
a. If Mountainside sells the property for $150,000 after holding it for one year, how much
gain or loss does it recognize and what is the character of its gain or loss? {Hint: See
§724.}
b. If Mountainside sells the property for $125,000 after holding it for two years, how much
gain or loss does it recognize and what is the character of the gain or loss?
c. If Mountainside sells the property for $150,000 after holding it six years, how much gain
or loss is recognized and what is the character of the gain or loss?
a. According to Section 724(c), recognized losses on assets that were

capital assets in the hands of contributing partners are treated as
capital losses up to the amount of loss built into the assets at the
time they were contributed if they are sold within a five year period
beginning on the date of contribution. Thus, Mountainside Develop-
ers will recognize a $50,000 loss characterized as a capital rather
than an ordinary loss.
b. In this instance, Mountainside Developers will recognize a $75,000

loss from the sale of the land. The built-in loss at the time the land
was contributed or $50,000 will be characterized as a capital loss,
and the remaining $25,000 loss will be characterized as an ordinary
loss per Section 724(c).
c. Because Mountainside Developers held the land as inventory for

more than five years, it will recognize a $50,000 ordinary loss per
Section 724(c).
46. [LO2] {Research} Claude purchased raw land three years ago for $1,500,000 to develop
into lots and sell to individuals planning to build their dream homes. Claude intended to
treat this property as inventory, like his other development properties. Before completing
the development of the property, however, he decided to contribute it to South Peak In-
20-34
vestors LLC when it was worth $2,500,000, in exchange for a 10 percent capital and profits
interest. South Peak’s strategy is to hold land for investment purposes only and then sell it
later at a gain.
20-35
a. If South Peak sells the property for $3,000,000 four years after Claude’s contribution,
how much gain or loss is recognized and what is its character? {Hint: See § 724.}
b. If South Peak sells the property for $3,000,000 five and one-half years after Claude’s
contribution, how much gain or loss is recognized and what is its character?
a. Under Section 724(b), any gain or loss on contributed property that

was treated as inventory by the contributing partner and sold by the
partnership during the five year period beginning on the date of con-
tribution is treated as ordinary gain or loss. Thus, the entire
$1,500,000 gain from the sale of the land will be treated as ordinary
gain.
b. Section 724(b) only applies if contributed property is sold during the

five year period beginning on the date of contribution. Because
South Peak sold the land after the expiration of this time period and
held the land as investment property, it should recognize $1,500,000
of capital gain.
47. [LO2] {Research} Reggie contributed $10,000 in cash and a capital asset he had held for
three years with a fair market value of $20,000 and tax basis of $10,000 for a 5 percent
capital and profits interest in Green Valley LLC.
a. If Reggie sells his LLC interest thirteen months later for $30,000 when the tax basis in
his partnership interest is still $20,000, how much gain does he report and what is its char-
acter?
b. If Reggie sells his LLC interest two months later for $30,000 when the tax basis in his
partnership interest is still $20,000, how much gain does he report and what is its
character? {Hint: See Reg. §1.1223-3}
20-36
48. [LO2] Connie recently provided legal services to the Winterhaven LLC and received a 5
percent interest in the LLC as compensation. Winterhaven currently has $50,000 of ac-
counts payable and no other debt. The current fair market value of Winterhaven’s capital is
$200,000.
a. If Connie receives a 5 percent capital interest only, how much income must she report
and what is her tax basis in the LLC interest?
b. If Connie receives a 5 percent profits interest only, how much income must she report
and what is her tax basis in the LLC interest?
c. If Connie receives a 5 percent capital and profits interest, how much income must she re-
port and what is her tax basis in the LLC interest?
a. Connie reports $10,000 of ordinary income or 5 percent of the LLC’s

capital of $200,000. Her basis in the LLC interest is also $10,000.
b. Connie will not report any income but will have a basis in the LLC in-
terest equal to her share of the LLC’s debt. Because the LLC’s debt is
a nonrecourse debt, it must be allocated to her using Connie’s profits
interest. Thus, her basis in the LLC equals $2,500 or 5 percent of the
LLC’s $50,000 accounts payable.
c. Connie reports $10,000 of ordinary income or 5 percent of the LLC’s

capital of $200,000. Her basis in the LLC is $12,500 consisting of the
$10,000 of income she recognizes for the receipt of her capital inter-
est and her $2,500 share of the LLC’s nonrecourse accounts payable.
49. [LO2] Mary and Scott formed a partnership that maintains its records on a calendar-year
basis. The balance sheet of the MS Partnership at year-end is as follows:
Basis Fair Market Value

Cash $ 60 $ 60
Land 60 180
Inventory 72 60
$192 $300
Mary $ 96 $150
Scott 96 150
$192 $300
At the end of the current year, Kari will receive a one-third capital interest only in ex-
change for services rendered. Kari’s interest will not be subject to a substantial risk of for-
feiture and the costs for the type of services she provided are typically not capitalized by
the partnership. For the current year, the income and expenses from operations are equal.
20-37
Consequently, the only tax consequences for the year are those relating to the admission of
Kari to the partnership.
20-38
a. Compute and characterize any gain or loss Kari may have to recognize as a result of her
admission to the partnership.
b. Compute Kari’s basis in her partnership interest.
c. Prepare a balance sheet of the partnership immediately after Kari’s admission showing
the partners’ tax capital accounts and capital accounts stated at fair market value.
d. Calculate how much gain or loss Kari would have to recognize if, instead of a capital in-
terest, she only received a profits interest.
a. Kari will recognize one-third of the fair market value of the partner-
ship’s capital or $100 as ordinary income.
b. Kari’s basis in her partnership interest will be equal to the amount of

income she reports or $100.
c. Immediately after Kari’s admission into the partnership the partner-

ship’s balance sheet will appear as follows:
MS Partnership
Balance Sheet
Tax Basis 704(b)/FMV
Assets:
Cash $60 60
Land 60 180
Inventory 72 60
Totals $192 300
Capital:
Capital-Mary 46 100
Capital-Scott 46 100
Capital-Kari 100 100
Totals $192 $300
Essentially, the tax capital and 704(b) capital accounts for both Scott
and Mary are reduced by their $50 share of the $100 compensation
expense the partnership will deduct for the capital interest Kari re-
ceives.
20-39
d. If Kari only receives a profits interest, she will not recognize any in-
come until she receives a profits allocation from the partnership.
50. [LO2] Dave LaCroix recently received a 10 percent capital and profits interest in Cirque
Capital LLC in exchange for consulting services he provided. If Cirque Capital had paid
an outsider to provide the advice, it would have deducted the payment as compensation ex-
pense. Cirque Capital’s balance sheet on the day Dave received his capital interest appears
below:
Assets: Basis Fair Market Value

Cash $ 150,000 $ 150,000
Investments 200,000 700,000
Land 150,000 250,000
Totals $ 500,000 $1,100,000
Liabilities and capital:

Nonrecourse Debt 100,000 100,000
Lance* 200,000 500,000
Robert* 200,000 500,000
Totals $ 500,000 $ 1,100,000
*Assume that Lance’s basis and Robert’s basis in their LLC interests equal their tax ba-
sis capital accounts.
a. Compute and characterize any gain or loss Dave may have to recognize as a result of his
admission to Cirque Capital.
b. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt
of his interest.
c. Prepare a balance sheet for Cirque Capital immediately after Dave’s admission showing
the members’ tax capital accounts and their capital accounts stated at fair market value.
d. Compute and characterize any gain or loss Dave may have to recognize as a result of his
admission to Cirque Capital if he receives only a profits interest.
e. Compute each member’s tax basis in his LLC interest immediately after Dave’s receipt
of his interest if Dave only receives a profits interest.
a. The tax consequences of giving Dave both a 10 percent capital and

profits interest are summarized in the following table:
20-40
Description Dave Lance Robert Explanation

(1) Beginning $0 $250,000 $250,000$200,000 tax basis capital
Basis in LLC account + [.5 x $100,000
nonrecourse debt]
(2) Ordinary In- $100,000 Liquidation Value of Capital
come Interest (.1 x $1,000,000 fair
market value of LLC capital)
(3) Ordinary ($50,000) ($50,000)Capital Shift from Non-Ser-
Deduction vice Partners.
(2) x .5
(4) Increase in $10,000 [$100,000 nonrecourse
Debt Allocation debt x 10% profit sharing ra-
tio]
(5) Decrease in (5,000) (5,000) (4) x .5
Debt Allocation
(6) Ending Ba- $110,000 $195,000 $195,000 (1) + (2) + (3) + (4) + (5)
sis in LLC
As indicated in line (2) of the table above, Dave recognizes $100,000

of ordinary income.
b. As indicated in line (6) of the table above, the member’s tax bases in
the LLC interests immediately after Dave is admitted are as follows:
$110,000 for Dave and $195,000 for Lance and Robert.
c. Immediately after Dave’s admission into the LLC, the LLC’s balance
sheet will appear as follows:
Cirque, LLC
Balance Sheet
Tax Basis 704(b/)FMV
Assets:
Cash $150,000 $150,000
Land 200,000 700,000
Inventory 150,000 250,000
Totals $500,000 $1,100,000
20-41
Capital:
Nonrecourse Debt $100,000 100,000
Capital-Lance 150,000 450,000
Capital-Robert 150,000 450,000
Capital-Dave 100,000 100,000
Totals $500,000 $1,100,000
d. The tax consequences of giving Dave only a 10 percent profits inter-

est are summarized in the following table:
20-42
Description Dave Lance Robert Explanation

(1) Begin- $0 $250,000 $250,000$200,000 tax basis capi-
ning Basis in tal account + [.5 x
LLC $100,000 nonrecourse
debt]
(2) Ordinary $0 Dave does not recognize
Income any income because he
only receives a profits in-
terest.
(3) Increase $10,000 [$100,000 nonrecourse
in Debt Allo- debt x 10% profit sharing
cation ratio]
(4) Decrease (5,000) (5,000) (3) x .5
in Debt Allo-
cation
(5) Ending $10,000 $245,000 $245,000 (1) + (2) + (3) + (4)
Basis in LLC
Dave does not recognize any income because he only received a

profits interest.
e. As reflected in line (5) of the table above, Dave’s basis is $10,000,

Lance’s basis is $245,000, and Robert’s basis is $245,000.
51. [LO 2] Last December 31, Ramon sold the 10 percent interest in the Del Sol Partnership
that he had held for two years to Garrett for $400,000. Prior to selling his interest, Ramon’-
s basis in Del Sol was $200,000 which included a $100,000 share of nonrecourse debt allo-
cated to him.
a. What is Garrett’s tax basis in his partnership interest?
b. If Garrett sells his partnership interests three months after receiving it and recognizes a
gain, what is the character of his gain?
20-43
a. Garrett’s basis in his partnership interest is equal to the $400,000

amount he paid for it plus his $100,000 share of partnership debt or
$500,000.
b. Because Garrett purchased his partnership interest, his holding peri-

od for the interest begins on the date the interest was purchased. As
a result, he only has a three month holding period before the partner-
ship interest is sold. This means his capital gain from the sale of his
partnership interest will be short-term capital gain.
52. [LO 3] Broken Rock LLC was recently formed with the following members:
Name Tax Year End Capital/Profits %

George Allen December 31 33.3%
Elanax Corp. June 30 33.3%
Ray Kirk December 31 33.3%
What is the required taxable year-end for Broken Rock LLC?
George Allen and Ray Kirk together own more than 50 percent of the
profits and capital of Broken Rock. Because both George and Ray have a
December 31 year end, December 31 is majority interest taxable year
and is also the required year end for Broken Rock.
53. [LO 3] Granite Slab LLC was recently formed with the following members:

Nelson Black December 31 22.0%
Brittany Jones December 31 24.0%
Lone Pine, LLC June 30 4.5%
Red Spot, Inc. October 31 4.5%
Pale Rock, Inc. September 30 4.5%
Thunder Ridge, LLC July 31 4.5%
Alpensee, LLC March 31 4.5%
Lakewood, Inc. June 30 4.5%
Streamside, LLC October 31 4.5%
Burnt Fork, Inc. October 31 4.5%
Snowy Ridge, LP June 30 4.5%
Whitewater, LP October 31 4.5%
Straw Hat, LLC January 31 4.5%
Wildfire, Inc. September 30 4.5%
20-44
What is the required taxable year-end for Granite Slab LLC?
Because none of the partners with the same year end together own
more than 50 percent of the capital and profits of Granite Slab, there is
no majority interest taxable year. However, Nelson Black and Brittany
Jones are principal partners because they individually own more than 5
percent of the profits and capital of Granite Slab. Moreover, they both
have a December 31 year end. Therefore, the required year end of the
partnership is year end of the principal partners or December 31.
20-45
54. [LO 3] Tall Tree LLC was recently formed with the following members:

Eddie Robinson December 31 40%
Pitcher Lenders, LLC June 30 25%
Perry Homes, Inc. October 31 35%
What is the required taxable year-end for Tall Tree LLC?
55. [LO 3] Rock Creek LLC was recently formed with the following members:

Mark Banks December 31 35%
Highball Properties, March 31 25%
LLC
Chavez Builders, Inc. November 30 40%
What is the required taxable year-end for Rock Creek LLC?
Rock Creek does not have a majority interest taxable year because no
partner or group of partners with the same year end owns more than 50
percent of the profits and capital interests in Rock Creek. Also, because
all three principal partners in Rock Creek have different year ends, the
principal partner test is not met. As a result, Rock Creek must decide
which of three potential year ends, December 31, March 31, or Novem-
ber 30, will provide its members the least aggregate deferral. The table
below illustrates the required computations:
Possible Year Ends 12/31 Year End 3/31 Year End 11/30 Year End
Members % Tax Months % x MD Months % x MD Months %x

Year Deferral* Deferral* Deferral* MD
(MD) (MD) (MD)
Mark Banks 35% 12/31 0 0 9 3.15 1 .35
Highball Prop- 25% 3/31 3 .75 0 0 4 1
erties, LLC
Chavez 40% 11/30 11 4.4 8 3.2 0 0
Builders,Inc.
Total Aggre- 5.15 6.35 1.35
gate Deferral
20-46
*Months deferral equals number of members between proposed year end and part-
ner’s year end.
As the table above indicates, Rock Creek must use November 30 as its year
end because it provides the least amount of aggregate deferral to the
members.
20-47
56. [LO 3]{Research} Ryan, Dahir, and Bill have operated Broken Feather LLC for the last
four years using a calendar year-end. Each has a one-third interest. Since they began oper-
ating, their busy season has run from June through August, with 35 percent of their gross
receipts coming in July and August. The members would like to change their tax year-end
and have asked you to address the following questions:
a. Can they change to an August 31 year-end and, if so, how do they make the change?
{Hint: See Rev. Proc. 2002-38.}
b. Can they change to a September 30 year-end and, if so, how do they make the change?
{Hint: See § 444.}
a. If Broken Feather can establish that 25 percent of its gross receipts

for the current twelve month period ending on August 31 fell within
the months of July and August, and it can establish the same thing for
the two preceding years ending on August 31, then Broken Feather
can change its year end to August 31 under Rev. Proc. 2002-38.
b. Under Section 444, Broken Feather can elect to have its year end fall
up to three months ahead of its normal required calendar year end.
Thus, it may elect to have a September 30, October 31, or November
30 year end under Section 444. However, if it makes the Section 444
election, it must calculate and deposit a Section 7519 payment with
the IRS to offset the deferral benefit the partners receive by having
the year end fall before December 31.
57. [LO 3] {Research}Ashlee, Hiroki, Kate, and Albee LLC each own a 25 percent interest in
Tally Industries LLC, which generates annual gross receipts of over $10 million. Ashlee,
Hiroki, and Kate manage the business, but Albee LLC is a nonmanaging member. Al-
though Tally Industries has historically been profitable, for the last three years losses have
been allocated to the members. Given these facts, the members want to know whether Tally
Industries can use the cash method of accounting. Why or why not? {Hint: See § 448(b)
(3)}
Generally, partnerships without corporate partners may use the cash

method of accounting. However, partnerships that are tax shelters may
not use the cash method of accounting. According to Section 448(b)(3),
partnerships defined as “tax shelters” are ineligible to use the cash
method. Section 461(i)(3)(B) includes “syndicates” among the other
categories of “tax shelters”. Section 1256(e)(3)(B) defines a syndicate
as any partnership that allocates more than 35 percent of its losses to
either limited partners or “limited entrepreneurs”. In addition to limited
partnerships, this provision likely also applies to LLCs because Section
464(e)(2) defines a limited entrepreneur as any person, including LLC
members, other than a limited partner, who does not actively participate
in the management of the enterprise. In summary, if more than 35 per-
cent of losses in a given year are allocated to either limited partners or
20-48
to LLC members not actively participating in the management of an LLC,

the limited partnership or LLC will be not be permitted to use the cash
method. Because of these restrictions, a significant number of limited
partnerships and LLCs that would otherwise qualify are denied the use of
the cash method.
20-49
Because only 25 percent of Tally Industries’ loss for the year is allocated
to a member that does not actively participate in management and it
does not have a corporate member, Tally will be able to use the cash
method.
58. [LO 4] Turtle Creek Partnership had the following revenues, expenses, gains, losses, and
distributions:
Sales revenue $40,000

Long-term capital gains $2,000
Cost of goods sold ($13,000)
Depreciation - MACRS ($3,000)
Amortization of organization costs ($1,000)
Guaranteed payments to partners for general management ($10,000)
Cash distributions to partners ($2,000)
Given these items, what is Turtle Creek’s ordinary business income (loss) for the year?
Turtle Creek’s ordinary business income is calculated in the table below:
Description Amount
Less:
Cost of good sold (13,000)
Depreciation - MACRS (3,000)
Amortization of organization costs (1,000)
Guaranteed payments (10,000)
Ordinary Business Income $13,000
Separately Stated Items on Schedule K-1:
Guaranteed payments $10,000
Cash distributions $2,000
Note that guaranteed payments must be separately disclosed to the

partners that receive them, and cash distributions must be separately
disclosed so that partners can reduce the tax basis of their partnership
interests by the amount of the distributions.
20-50
59. [LO 4] Georgio owns a 20 percent profits and capital interest in Rain Tree LLC. For the
current year, Rain Tree had the following revenues, expenses, gains, and losses:

Gain on sale of land (§1231) $11,000
Section 179 deduction* ($10,000)
Employee wages ($11,000)
Fines and penalties ($3,000)
Municipal bond interest $6,000
Short-term capital gains $4,000
Guaranteed payment to Sandra ($3,000)
*Assume the §179 property placed in service limitation does not apply.
a. How much ordinary business income (loss) is allocated to Georgio for the year?
b. What are Georgio’s separately stated items for the year?
a. Georgio’s allocation of ordinary business income is reflected in the ta-

ble below:
Description Total Amount 20% Allocat-

ed to Geor-
gio
Less:
Employee wages (11,000)
Ordinary Business Income $27,000 $5,400
20-51
b. Georgio’s separately stated items are calculated in the table below:
20-52
Description Total Amount 20% Allocat-

ed to Geor-
gio
Separately Stated Items on Schedule K-1:
Section 1231 gains $11,000 $2,200
Section 179 deduction (10,000) (2,000)
Short-term capital gains 4,000 800
Municipal bond interest* 6,000 1,200
Fines and penalties* (3,000) (600)
*Although these amounts are not included in Georgio’s taxable income

computation, they must be separately disclosed because they affect
Georgio’s tax basis in his LLC interest.
60. [LO 4] The partnership agreement of the G&P general partnership states that Gary will re-
ceive a guaranteed payment of $13,000, and that Gary and Prudence will share the remain-
ing profits or losses in a 45/55 ratio. For year 1, the G&P partnership reports the following
results:

Gain on sale of land (§ 1231) $8,000
Cash charitable contributions ($3,000)
Municipal bond interest $2,000
Other expenses ($2,000)
a. Compute Gary’s share of ordinary income (loss) and separately stated items to be report-
ed on his year 1 Schedule K-1, including his self-employment income (loss).
b. Compute Gary’s share of self-employment income (loss) to be reported on his year 1

Schedule K-1, assuming G&P is a limited partnership and Gary is a limited partner.
c. What do you believe Gary’s share of self-employment income (loss) to be reported on

his year 1 Schedule K-1 should be, assuming G&P is an LLC and Gary spends 2,000 hours
per year working there full time?
20-53
Gary’s ordinary business income, separately stated items, and self-em-
Description Total Amount Allocated to Gary Explanation

Less:
Other expenses (2,000)
Ordinary Business Loss ($6,000) ($2,700) 45% allocation to
Gary
Separately Stated Items
on Schedule K-1:
Section 1231 gains $8,000 $3,600 45% allocation to
Gary
Cash charitable contri- ($3,000) ($1,350) 45% allocation to
Gary
butions
Guaranteed payment $13,000 $13,000 Gary’s guaranteed
payment
Municipal bond interest $2,000 $900 45% allocation to
Gary
Self-employment in- $7,000 $10,300 ($2,700) ordinary
come [$13,000 business loss allocat-
guaranteed ed to Gary +
payment - $13,000 guaranteed
$6,000 ordi- payment
nary loss]
ployment income are calculated in the table below:
20-54
a. If Gary is a limited partner, then his self-employment income would

equal the $13,000 guaranteed payment he received.
b. Under Proposed Reg. §1.1402(a)-2, Gary’s $2,700 share of ordinary

business loss will reduce his $13,000 guaranteed payment leaving
him with $10,300 of self-employment income (because he spent
more than 500 hours working in the trade or business of the LLC). In
this instance, the proposed regulations provide Gary with a favorable
interpretation of the law.
61. [LO 4] {Research} Hoki Poki, a cash-method general partnership, recorded the following
items for its current tax year:
Rental real estate income $2,000

Section 1245 recapture income $8,000
Interest income $2,000
Supplies expense ($1,000)
Investment interest expense ($1,000)
Partner’s medical insurance premiums paid by Hoki Poki ($3,000)
As part of preparing Hoki Poki’s current year return, identify the items that should be in-
cluded in computing its ordinary business income (loss) and those that should be separately
stated. {Hint: See Schedule K-1 and related preparer’s instructions at www.irs.gov.}
20-55
62. [LO 4] {Research} On the last day of its current tax year, Buy Rite LLC received $300,000
when it sold a machine it had purchased for $200,000 three years ago to use in its business.
At the time of the sale, the basis in the equipment had been reduced to $100,000 due to tax
depreciation taken. How much did Buy Rite’s self-employment earnings increase when the
equipment was sold? {Hint: See §1402(a)(3).}
Buy Rite’s self-employment income does not increase due to the sale of
the equipment. According to §1402(a)(3)(C), gains from the sale of
equipment are not included in Buy Rite’s self-employment income.
Thus, Buy Rite must insure that the $100,000 of ordinary Section 1245
recapture is subtracted from its ordinary business income or loss when
calculating its self-employment income. Because the remaining
$100,000 of Section 1231 gain is separately stated, it is not included in
ordinary business income or loss and therefore will not be included in
self-employment income.
63. [LO 4] Jhumpa, Stewart, and Kelly are all one-third partners in the capital and profits of
Firewalker general partnership. In addition to their normal share of the partnership’s annu-
al income, Jhumpa and Stewart receive an annual guaranteed payment of $10,000 to com-
pensate them for additional services they provide. Firewalker’s income statement for the
current year reflects the following revenues and expenses:
20-56

Interest income 3,300
Long-term capital gains 1,200
Depreciation expense (28,000)
Miscellaneous expenses (4,500)
Overall net income $97,000
a. Given Firewalker’s operating results, how much ordinary business income (loss) and
what separately stated items [including the partners’ self-employment earnings (loss)] will
it report on its return for the year?
b. How will it allocate these amounts to its partners?
c. How much self-employment tax will each partner pay assuming none have any other
source of income or loss?
20-57
The table below illustrates Firewalker’s ordinary business income and

separately stated items. Note that the total self employment income for
all partners consists of Firewalker’s $92,500 ordinary business income
(because ordinary business income from a general partnership is always
treated as self-employment income by the partners) plus the $20,000 in
Description Total Jhumpa Stewart Kelly

Less:
Misc. expenses (4,500)
Ordinary Business Income $92,500 $30,833 $30,833 $30,833
Separately Stated Items
on Schedule K-1:
Interest income $3,300 $1,100 $1,100 $1,100
Long-term capital gains $1,200 $400 $400 $400
Self-employment income $112,500 $40,833 $40,833 $30,833
guaranteed payments made to Dave and Stewart.
a. The table above reflects the partner’s shares of ordinary business in-
come and her/his separately stated items. Note that each partner’s
self employment income consists of her/his individual shares of ordi-
20-58
nary business income plus the guaranteed payment she/he received,

if any.
20-59
b. The table below reflects the partner’s self-employment tax liability:
Description Stewart Jhumpa Kelly Explanation

(1)Self-employment in- $40,833 $40,833 $30,833
come
(2) Percentage of self 92.35% 92.35% 92.35%
employment income
subject to self-employ-
ment tax
(3) Earnings from self- $37,709 $37,709 $28,474 (1) x (2)
employment
(4) Self employment 15.3% 15.3% 15.3%
tax rate
(7) Self-employment $5,769 $5,769 $4,357 (3) x (4)
tax liability
64. [LO 4] {Research} Lane and Cal each own 50 percent of the profits and capital of High-
Yield LLC. HighYield owns a portfolio of taxable and municipal bonds, and each year the
portfolio generates approximately $10,000 of taxable interest and $10,000 of tax- exempt
interest. Lane’s marginal tax rate is 35 percent while Cal’s marginal tax rate is 15 percent.
To take advantage of the difference in their marginal tax rates, Lane and Cal want to modi-
fy their operating agreement to specially allocate all of the taxable interest to Cal and all of
the tax-exempt interest to Lane. Until now, Lane and Cal had been allocated 50 percent of
each type of interest income.
a. Is HighYield’s proposed special allocation acceptable under current tax rules? Why or
why not? {Hint: See Reg. §1.704-1(b)(2)(iii)(b) and §1.704-1(b)(5) Example (5).}
b. If the IRS ultimately disagrees with HighYield’s special allocation, how will it likely re-
allocate the taxable and tax-exempt interest among the members? {Hint: See Reg. §1.704-
1(b)(5) Example (5)(ii).}
a. According to IRC §704 partnership allocations will be respected by the

IRS unless they do not have “substantial economic effect.” The facts
provided are almost identical to the general scenario described in
Reg. §1.704-1(b)(2)(iii)(b) and to the detailed facts described in
§1.704-1(b)(5) Example (5) given that the special allocation to Lane
and Cal simply changes the character of the income allocated to Lane
and Cal but not the amount. Thus, this allocation is not appropriate
because it is not substantial.
20-60
b. As described in Reg. §1.704-1(b)(5) Example (5)(ii), the IRS will likely

assert that 50 percent of both the taxable and tax-exempt bond inter-
est should be allocated to Lane and Cal.
65. [LO 5] Larry’s tax basis in his partnership interest at the beginning of the year was
$10,000. If his share of the partnership debt increased by $10,000 during the year and his
share of partnership income for the year is $3,000, what is his tax basis in his partnership
interest at the end of the year?
$23,000 as computed in the table below:
Description Total Amount

Beginning Tax Basis $10,000
Increase in Partner’s 10,000
Share of Debt
Partner’s Share of In- 3,000
come
Ending Tax Basis $23,000
66. [LO 5] Carmine was allocated the following items from the Piccolo LLC for last year:
Ordinary business loss

Nondeductible penalties
Tax-exempt interest income
Short-term capital gain
Cash distributions
Rank these items in terms of the order they should be applied to adjust Carmine’s tax basis
in Piccolo for the year.
Items that increase basis are applied first, then distributions, and then
items that reduce basis. Thus, the items above should be applied in the
following order to adjust Carmine’s tax basis:
Tax Exempt Income and Short Term Capital Gain (basis increasing items
come first)
Cash Distribution (distributions come after basis increasing items)
Ordinary Business Loss and Non-Deductible Penalties (basis reducing
items come last)
67. [LO 5] Oscar, Felix, and Marv are all one-third partners in the capital and profits of East-
side general partnership. In addition to their normal share of the partnership’s annual in-
come, Oscar and Felix receive annual guaranteed payments of $7,000 to compensate them
for additional services they provide. Eastside’s income statement for the current year re-
flects the following revenues and expenses:
20-61
20-62
Sales revenue $ 420,000

Dividend income 5,700
Short-term capital gains 2,800
Overall net income $ 52,000
In addition, Eastside owed creditors $120,000 at the beginning of the year but managed to
pay down its debts to $90,000 by the end of the year. All partnership debt is allocated
equally among the partners. Finally, Oscar, Felix and Marv had a tax basis of $80,000 in
their interests at the beginning of the year.
a. What tax basis do the partners have in their partnership interests at the end of the year?
b. Assume the partners began the year with a tax basis of $10,000 and all the debt was paid
off on the last day of the year. How much gain will the partners recognize when the debt is
paid off? What tax basis do the partners have in their partnership interests at the end of the
year?
20-63
a. All of the partners have an ending tax basis of $87,333 as calculated

in the table below:
Description Oscar Felix Marv Explanation

(1)Beginning tax $80,000 $80,000 $80,000
basis (including
partners’ share of
debt)
(2)Dividend income $1,900 $1,900 $1,900 $5,700 x 33.33%
(3)Short-term capi- $933 $933 $933 $2,800 x 33.33%
tal gains
(4)Partner’s share $14,500 $14,500 $14,500[$52,000 overall net
of ordinary business income - ($5,700
income Dividend Income +
$2,800 Short-Term
Capital Gains)] x
33.3%
(5)Deemed distribu- ($10,000) ($10,000) ($10,000) [$120,000 -
tion from debt re- $90,000] x 33.33%
payment
(6)Guaranteed pay- 0 0 Partners don’t in-
ments received crease the basis of
their partnership in-
terests by the
amount of guaran-
teed payments re-
ceived
(7)Ending tax basis $87,333 $87,333 $87,333 (1)+(2)+(3)+(4)+(5
)
20-64
b. Each partner recognizes gain of $12,667 and has an ending basis of

zero as calculated in the table below:
Description Oscar Felix Marv Explanation

(1)Beginning tax $10,000 $10,000 $10,000
Basis (including
partners’ share of
debt)
(2)Dividend income $1,900 $1,900 $1,900 $5,700 x 33.33%
(3)Short-term capi- $933 $933 $933 $2,800 x 33.33%
tal gains
(4)Partner’s share $14,500 $14,500 $14,500 [$52,000 overall net
of ordinary busi- income - ($5,700
ness income Dividend Income +
$2,800 Short-Term
Capital Gains)] x
33.3%
(5)Deemed distri- ($40,000) ($40,000) ($40,000) [$120,000 - $0] x
bution from debt 33.33%
repayment
(6)Guaranteed pay- 0 0 Partners don’t in-
their partnership in-
terests by the
amount of guaran-
teed payments re-
ceived
(7)Gain recognized $12,667 $12,667 $12,667 -
by partners [(5)+(1)+(2)+(3)+(4)
]
(8)Ending tax basis 0 0 0 Generally
(1)+(2)+(3)+(4)+(5)
but may not go lower
than zero
68. [LO 5] Pam, Sergei, and Mercedes are all one-third partners in the capital and profits of
Oak Grove General Partnership. Partnership debt is allocated among the partners in accor-
dance with their capital and profits interests. In addition to their normal share of the part-
nership’s annual income, Pam and Sergei receive annual guaranteed payments of $20,000
to compensate them for additional services they provide. Oak Grove’s income statement
for the current year reflects the following revenues and expenses:

Dividend income 6,600
Section 1231 losses (3,800)
20-65

Overall net income $ 60,000
20-66
In addition, Oak Grove owed creditors $90,000 at the beginning and $150,000 at the end of
the year, and Pam, Sergei and Mercedes had a tax basis of $50,000 in their interests at the
beginning of the year. Also, Sergei and Mercedes agreed to increase Pam’s capital and
profits interest from 33.3 percent to 40 percent at the end of the tax year in exchange for
additional services she provided to the partnership. The liquidation value of the additional
capital interest Pam received at the end of the tax year is $40,000.
a. What tax basis do the partners have in their partnership interests at the end of the year?
b. If, in addition to the expenses listed above, the partnership donated $12,000 to a political
campaign, what tax basis do the partners have in their partnership interests at the end of the
year assuming the liquidation value of the additional capital interest Pam receives at the
end of the year remains at $40,000?
a. Pam’s basis is $140,000, Sergei’s basis is $65,000, and Mercedes’s

basis is $65,000 as computed in the table below:
Description Pam Sergei Mercedes Explanation

(1)Beginning tax basis (in- $50,000 $50,000 $50,000 Given
cluding partners’ share of
debt)
(2) Dividends income $2,200 $2,200 $2,200 $6,600 x 33.33%
(Pam’s profits inter-
est doesn’t in-
crease until the
end of the year)
(3)Partner’s share of ordinary $19,067 $19,067 $19,067 [$60,000 overall
net income -
business income
($6,600 Dividend
Income - ($3,800)
Section 1231 Loss-
es)] x 33.3%
(4) Debt increase (deemed $30,000 $15,000 $15,000 Pam :[( $150,000 x
cash contribution) 40%) – ($90,000 x
33.33%)]
Other Partners:
[($150,000 x 30%)
– ($90,000 x
33.33%)]
20-67
(5) Pam’s new 6.67% capital $40,000 ($20,000) ($20,000) Additional 6.67%
interest capital interest to
Pam is a guaran-
teed payment to
Pam and a deduc-
tion allocated
equally to other
partners
(6) Cash guaranteed pay- 0 0 Partners don’t in-
their partnership
interests by the
amount of cash
guaranteed pay-
ments received
(7) Section 1231 losses ($1,267)($1,267) ($1,267) ($3,800) x 33.33%
(8)Ending tax basis $140,000 $65,000 $65,000Sum of (1) through
(7)
b. Pam’s basis is $136,000, Sergei’s basis is $61,000, and Mercedes’ ba-

sis is $61,000 as computed in the table below:
Description Pam Sergei Mercedes Explanation

Ending tax basis given facts $140,000 $65,000 $65,000See solution to part
in part a. a. above
Campaign contribution ($4,000) ($4,000) ($4,000)($12,000) x
33.33% Non-de-
ductible expenses
must reduce a part-
ner’s tax basis
New ending basis given facts $136,000 $61,000 $61,000
in part b.
69. [LO 6] Alfonso began the year with a tax basis in his partnership interest of $30,000. His
share of partnership debt at the beginning and end of the year consists of $5,000 of re-
course debt and $5,000 of nonrecourse debt. During the year, he was allocated $40,000 of
partnership ordinary business loss. Alfonso does not materially participate in this partner-
ship and he has $1,000 of passive income from other sources.
20-68
20-69
a. How much of Alfonso’s loss is limited by his tax basis?
b. How much of Alfonso’s loss is limited by his at-risk amount?
c. How much of Alfonso’s loss is limited by the passive activity loss rules?
a. Because Alfonso’s basis before the loss allocation is $30,000,

$10,000 of his $40,000 loss allocation is limited by his tax basis and
will carryover to the following year.
b. Of the $30,000 loss not already limited by Alfonso’s tax basis, $5,000
is limited because Alfonso’s at-risk amount is only $25,000 ($30,000
regular tax basis less the $5,000 nonrecourse debt not allowed in cal-
culating the at-risk amount). Thus, $25,000 of loss remains after the
tax basis and at-risk limitations and Alfonso has a $5,000 at-risk car-
ryover.
c. Because Alfonso doesn’t materially participate in the partnership, he

may only deduct the $25,000 loss remaining after the tax basis and
at-risk limitations to the extent he has passive income from other
sources. Thus, he may deduct $1,000 of the $25,000 loss currently
and will have a $24,000 passive activity loss carryover.
70. [LO 5, 6] {Research} Juan Diego began the year with a tax basis in his partnership interest
of $50,000. During the year, he was allocated $20,000 of partnership ordinary business in-
come, $70,000 of §1231 losses, $30,000 of short-term capital losses, and received a cash
distribution of $50,000.
a. What items related to these allocations does Juan Diego actually report on his tax return
for the year? {Hint: See Reg. §1.704-1(d)(2) and Rev. Rul. 66-94.}
b. If any deductions or losses are limited, what are the carryover amounts and what is their
character? {Hint: See Reg. §1.704-1(d).}
20-70
a. According to Rev. Rul. 66-94, Juan Diego should increase his basis
first by his $20,000 share of ordinary business income and then re-
duce it by his $50,000 cash distribution. At this point, his remaining
basis of $20,000 will be reduced to zero by the $70,000 Section 1231
losses and $30,000 short-term capital losses allocated to him. Reg.
§1.704-1(d)(2) describes how Juan Diego’s $20,000 tax basis before
considering the loss allocations should be allocated to the two types
of losses. The table below illustrates the required calculations:
(1) Original (2) Amount Deducted (1) – (2) Loss

Loss Currently Carryover
Section 1231 loss- $70,000 $14,000 $56,000
es ($20,000 x
$70,000/$100,000)
Short-term capital $30,000 $6,000 $24,000
losses ($20,000 x
$30,000/$100,000)
b. As indicated in the table above, Juan Diego’s $80,000 loss carryover

(due to his $20,000 tax basis limitation) will be characterized as a
$56,000 Section 1231 loss and a $24,000 short-term capital loss.
71. [LO 6] Farell is a member of Sierra Vista LLC. Although Sierra Vista is involved in a
number of different business ventures, it is not currently involved in real estate either as an
investor or as a developer. On January 1, year 1, Farell has a $100,000 tax basis in his LLC
interest that includes his $90,000 share of Sierra Vista’s general debt obligations. By the
end of the year, Sierra Vista’s general debt obligations have increased to $100,000. Be-
cause of the time he spends in other endeavors, Farell does not materially participate in
Sierra Vista. His share of the Sierra Vista losses for year 1 is $120,000 and, as a partner in
the Riverwoods Partnership, he has year 1 Schedule K-1 passive income of $5,000.
a. Determine how much of the Sierra Vista loss Farell will currently be able to deduct on
his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive
activity loss limitations.
b. Assuming Farrell’s Riverwoods K-1 indicates passive income of $30,000, determine how
much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year
1 and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
c. Assuming Farrell is deemed to be an active participant in Sierra Vista, determine how

much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year
1 and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.
20-71
a.
72. [LO 6] {Research} Jenkins has a one-third capital and profits interest in the Maverick Gen-
eral Partnership. On January 1, year 1, Maverick has $120,000 of general debt obligations
and Jenkins has a $50,000 tax basis in his partnership interest. During the year, Maverick
incurred a $30,000 in nonrecourse debt that is not secured by real estate. Because Maver-
ick is a rental real estate partnership, Jenkins is deemed to be a passive participant in Mav-
erick. His share of the Maverick losses for year 1 is $105,000. Jenkins is not involved in
any other passive activities and this is the first year he has been allocated losses from Mav-
erick.
20-72
a. Determine how much of the Maverick loss Jenkins will currently be able to deduct on his
tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive ac-
tivity loss limitations.
b. If Jenkins sells his interest on January 1, year 2, what happens to his suspended losses
from year 1? {Hint: See Sennett v. Commissioner 80 TC 825 (1983) and Prop. Reg.
§1.465-66(a).}
a. Jenkins may not deduct any losses currently, and he will have a
$25,000 loss suspended by the tax basis limitation, a $30,000 loss
suspended by the at-risk limitation, and a $50,000 loss suspended by
the passive activity loss limitation as illustrated in the table below:
20-73
20-74
Description Tax Basis At-risk Limita- Passive Activi- Explanation

Limitation tion ty Limitation
(1) Beginning $50,000 $50,000 General debt obliga-
Tax basis and At- tions of general part-
risk amount nerships are treated
as recourse debt.
Thus, Jenkins’ begin-
ning at-risk amount is
the same as his be-
ginning tax basis.
(2) Increase in $30,000 $0 Nonrecourse debt
nonrecourse generally not includ-
debt ed in at-risk amount.
(3) Tax basis and $80,000 $50,000 (1) + (2)
At-risk amount
before ordinary
business loss
(4) Ordinary ($105,000)
business loss
(5) Loss clearing ($80,000) Loss limited to
the Tax basis $80,000 tax basis
hurdle
(6)Loss suspend- ($25,000) (4) - (5)
ed by Tax basis
hurdle
(7) Loss clearing ($80,000) (5)
Tax basis hurdle
At-risk hurdle $50,000 at-risk
amount
(9) Loss sus- ($30,000) (7) - (8)
pended by At-
risk hurdle
(10) Passive ac- ($50,000) (8)Jenkins is not a
tivity loss material participant
(11) Passive in- $0 Given
come
(12) Loss used to $0 Loss only used to the
offset Passive in- extent of passive in-
come come
(13) Passive ac- ($50,000) (10) – (12)
tivity loss carry-
over
20-75
20-76
b. According to Sennett v. Commissioner 80 TC 825 (1983), a partner

with losses suspended by the tax basis limitation disappear when the
partnership interest is sold. Thus, Jenkins will lose the $25,000 loss
suspended by the tax basis limitation. In addition, Prop. Reg. §1.465-
66(a) provides that Jenkins may utilize the $30,000 loss suspended
by the at-risk limitation to offset any gain he would otherwise report
from the disposition of his partnership interest. Finally, Jenkins may
deduct the $50,000 passive activity loss carryover in the year of dis-
position.
73. [LO 6] {Planning} Suki and Steve own 50 percent capital and profits interests in Lorinda
LLC. Lorinda operates the local minor league baseball team and owns the stadium where
the team plays. Although the debt incurred to build the stadium was paid off several years
ago, Lorinda owes its general creditors $300,000 (at the beginning and end of the year) that
is not secured by firm property or guaranteed by any of the members. At the beginning of
the current year Suki and Steve had a tax basis of $170,000 in their LLC interests including
their share of debt owed to the general creditors. Shortly before the end of the year they
each received a $10,000 cash distribution, even though Lorinda’s ordinary business loss for
the year was $400,000. Because of the time commitment to operate a baseball team, both
Suki and Steve spent more than 1,500 hours during the year operating Lorinda.
a. Determine how much of the Lorinda loss Suki and Steve will each be able to deduct on
their current tax returns, and list their losses suspended by the tax basis, at-risk, and passive
activity loss limitations.
b. Assume that sometime before receiving the $10,000 cash distribution, Steve is advised
by his tax advisor that his marginal tax rate will be abnormally high during the current year
because of an unexpected windfall. To help Steve utilize more of the losses allocated from
Lorinda in the current year, his advisor recommends refusing the cash distribution and per-
sonally guaranteeing $100,000 of Lorinda’s debt, without the right to be reimbursed by
Suki. If Steve follows his advisor’s recommendations, how much additional Lorinda loss
can he deduct on his current tax return? How does Steve’s decision affect the amount of
loss Suki can deduct on her current return and the amount and type of her suspended loss-
es?
20-77
a. The members (either Steve or Suki) may deduct $10,000 in losses

currently, and they will have a $40,000 loss suspended by the tax ba-
sis limitation, and a $150,000 loss suspended by the at-risk limitation
Description Tax Basis At-risk Limita- Explanation
Limitation tion
(1) Beginning $170,000 $20,000 General debt obligations of LLCs
Tax basis and At- are treated as nonrecourse debt.
risk amount Thus, Suki or Steve’s beginning
at-risk amount is $150,000 less
than their beginning tax basis.
(2) Distribution ($10,000) ($10,000)
(3) Tax basis and $160,000 $10,000 (1) + (2)
At-risk amount
before ordinary
business loss
(4) Ordinary ($200,000) $400,000 x50%

business loss
(5) Loss clearing ($160,000) Loss limited to $160,000 tax ba-
the Tax basis sis
hurdle
(6)Loss suspend- ($40,000) (4) - (5)

ed by Tax basis
hurdle
(7) Loss clearing ($160,000) (5)
Tax basis hurdle
(8) Loss clearing ($10,000) Loss limited to $10,000 at-risk
At-risk hurdle amount on line (3). This amount
and currently de- is currently deductible because
ductible Steve is an active participant in
the activity.
(9) Loss sus- ($150,000) (7) - (8)
pended by At-
risk hurdle
as illustrated in the table below:
20-78
Under these facts, Steve may deduct $120,000 in losses currently (a

$110,000 increase over the loss he could deduct in part a.), and will

Limitation tion
(1) Beginning $170,000 $20,000 General debt obligations
Tax basis and At- of LLCs are treated as
risk amount nonrecourse debt. Thus,
Steve’s beginning at-risk
amount is $150,000 less
than his beginning tax ba-
sis.
(2) Increase in $50,000 $100,000 [(100,000 + 50% x
debt allocation $200,000) - $150,000] for
tax basis and [100,000 –
0] for at-risk amount be-
cause guaranteeing the
debt makes it recourse
debt
(3) Tax basis and $220,000 $120,000 (1) + (2)
At-risk amount
before ordinary
business loss
(4) Ordinary ($200,000)
business loss
(5) Loss clearing ($200,000) Loss is less than tax basis
the Tax basis limitation
hurdle
(6)Loss suspend- $0 (4) - (5)
ed by Tax basis
hurdle
(7) Loss clearing ($200,000) (5)
Tax basis hurdle
(8) Loss clearing ($120,000) Loss is limited to at-risk
At-risk hurdle amount on line (3). This
and currently de- amount is currently de-
ductible ductible because Steve is
an active participant in
the activity.
(9) Loss sus- ($80,000) (7) - (8)
pended by At-
risk hurdle
have a $80,000 loss suspended by the at-risk limitation as illustrated in

the table below:
20-79
Suki may deduct $10,000 in losses currently (the same amount of loss
as in part a.), and she will have a $90,000 loss suspended by the tax
basis limitation and a $100,000 loss suspended by the at-risk limita-
tion as illustrated in the table below:
20-80
20-81

Limitation tion
(1) Beginning $170,000 $20,000 General debt obligations
Tax basis and At- of LLCs are treated as
risk amount nonrecourse debt. Thus,
Suki’s beginning at-risk
amount is $150,000 less
than her beginning tax
basis.
(2) Distribution ($10,000) ($10,000)
(3) Decrease in ($50,000) $0 [($200,000 x 50% ) –
debt allocation ($300,000 x 50%)]
(4) Tax basis and $110,000 $10,000 (1) + (2)+ (3)
At-risk amount
before ordinary
business loss
(5) Ordinary ($200,000)
business loss
(6) Loss clearing ($110,000) Loss is limited to the tax
the Tax basis basis
hurdle
(6)Loss suspend- ($90,000) (5) - (6)

ed by Tax basis
hurdle
(7) Loss clearing ($110,000) (6)
Tax basis hurdle
(8) Loss clearing ($10,000) Loss is limited to at-risk
At-risk hurdle amount on line (4). This
and currently de- amount is currently de-
ductible ductible because Suki is
an active participant in
the activity.
(9) Loss sus- ($100,000) (7) - (8)
pended by At-
risk hurdle
74. [LO 6]{Research} Ray and Chuck own 50 percent capital and profits interests in Alpine
Properties LLC. Alpine builds and manages rental real estate, and Ray and Chuck each
work full time (over 1000 hours per year) managing Alpine. Alpine’s debt (both at the be-
ginning and end of the year) consists of $1,500,000 in nonrecourse mortgages obtained
from an unrelated bank and secured by various rental properties. At the beginning of the
current year, Ray and Chuck each had a tax basis of $250,000 in his LLC interest including
his share of the nonrecourse mortgage debt. Alpine’s ordinary business losses for the cur-
rent year totaled $600,000 and neither member is involved in other activities that generate
passive income.
20-82
a. How much of each member’s loss is suspended because of the tax basis limitation?
b. How much of each member’s loss is suspended because of the at-risk limitation?
c. How much of each member’s loss is suspended because of the passive activity loss limi-
tation? {Hint: See §469(b)(7).}
a. Each member will have $50,000 of loss suspended because of the tax
basis limitation as reflected in the table below:
Description Tax Basis At-risk Limita- Passive Activi- Explanation

Limitation tion ty Limitation
(1) Beginning $250,000 $250,000 Because the LLC’s
Tax basis and At- mortgage debt is
risk amount qualified nonrecourse
financing, it is includ-
ed in both the tax ba-
sis and at-risk amount
(2) Ordinary ($300,000) 50% x $600,000
business loss
the Tax basis $250,000 tax basis
hurdle
(4) Loss sus- ($50,000) (2) - (3)
pended by Tax
basis hurdle
(5) Loss clearing ($250,000) (3)
Tax basis hurdle
At-risk hurdle $250,000 at-risk
amount
(7) Loss sus- $0 (7) - (8)
pended by At-
risk hurdle
20-83
b. As indicated in the table above, none of the members’ loss allocation

will be suspended because of the at-risk limitation.
c. Each member’s $250,000 loss remaining after the tax basis and at-
risk limitations (see table in part a.) is deductible currently. Although
rental real estate ventures are generally treated as passive activities
under §469(c)(2), §469(b)(7) provides an exception for taxpayers that
work more than half of the time in real property trades or businesses
and work more than 750 hours in real property trades or businesses
in a given year. Given the facts in this problem, both members will
be treated as active participants and will therefore be able to immedi-
ately deduct $250,000.
20-84
Comprehensive Problems
75. [LO 2, 4, 5] Aaron, Deanne, and Keon formed the Blue Bell General Partnership at the be-
ginning of the current year. Aaron and Deanne each contributed $110,000 and Keon trans-
ferred an acre of undeveloped land to the partnership. The land had a tax basis of $70,000
and was appraised at $180,000. The land was also encumbered with a $70,000 nonrecourse
mortgage for which no one was personally liable. All three partners agreed to split profits
and losses equally. At the end of the first year Blue Bell made a $7,000 principal payment
on the mortgage. For the first year of operations, the partnership records disclosed the fol-
lowing information:

Cost of goods sold $410,000
Operating expenses $70,000
Section 1231 gains $900
Charitable contributions $300
Municipal bond interest $300
Salary paid as a guaranteed payment to Deanne (not included in expenses) $3,000
a. Compute the adjusted basis of each partner’s interest in the partnership immediately after
the formation of the partnership.
b. List the separate items of partnership income, gains, losses, and deductions that the part-
ners must show on their individual income tax returns that include the results of the part-
nership’s first year of operations.
c. (Optional) Using the information generated in answering parts a. and b., prepare Blue
Bells’ page 1 and Schedule K to be included with its Form 1065 for its first year of opera-
tions along with Schedule K-1 for Deanne.
d. What are the partners’ adjusted bases in their partnership interests at the end of the first
year of operations?
20-85
a. This initial adjusted basis for Keon is $23,333, for Aaron is $133,333,
and for Deanne is $133,333 as shown in the calculations with table
below:
Description Keon Aaron Deanne Explanation

land
(3) Debt allocated to $23,333 $23,333 $23,333
partners
(4) Relief from nonre- ($70,000)
course mortgage
(5) Gain recognized $0 $0 $0(4 )- [(1)+
(2)+ (3)] if
positive, oth-
erwise 0
(6) Partners’ initial tax $23,333 $133,333 $133,333(1) + (2) +
basis (3)+ (4) +
(5)
b. The partners’ shares of ordinary business loss and separately stated

items are reflected in the table below:
20-86
Description Total Keon Aaron Deanne Explanation

(1) Partners’ initial $23,333 $133,333 $133,333See problem
Tax basis a. above
(2) Sales revenue $470,000
Less:
(3) Cost of goods (410,000)
sold
(4) Operating ex- (70,000)
penses
(5) Guaranteed (3,000)
payments
(6) Ordinary Busi- ($13,000) ($4,333) ($4,333) ($4,333)[Sum of (2)
through (5)]
ness Loss
x 33.33%
Separately Stated
Items on Schedule
K-1:
(7) Long-term capi- $2,400 $800 $800 $800$2,400 x
33.33%
tal gains
(8) Section 1231 $900 $300 $300 $300$900 x
33.33%
gains
(9) Municipal bond $300 $100 $100 $100$300 x
33.33%
interest
(10) Charitable con- ($300) ($100) ($100) ($100)($300) x
33.33%
tributions
(11) Mortgage re- ($7,000) ($2,333) ($2,333) ($2,333)($7,000) x
33.33%
duction (deemed
cash distribution)
20-87
(12) Self-employ- ($10,000) ($4,333) ($4,334) ($1,333)Line 6 +

ment Loss $3,000 guar-
anteed pay-
ment to
Deanne
Partners’ ending $17,767 127,767 127,767(1) + (6)+
tax basis (7) through
(11)
20-88
c. Blue Bell Partnership’s page 1 and Schedule K to be included with

Form 1065 and Deanne’s Schedule K-1 are shown below:
20-89
20-90
20-91
d. Keon has an ending basis of $17,767, Aaron has an ending basis of

$127,767 and Deanne has an ending basis of $127,767. These
amounts are calculated in the table included with the solution to part
b. above.
76. [LO 4, 5, 6] The TimpRiders Limited Partnership has operated a motorcycle dealership for
a number of years. Lance is the limited partner, Francesca is the general partner, and they
share capital and profits equally. Francesca works full-time managing the partnership.
Both the partnership and the partners report on a calendar-year basis. At the start of the
current year, Lance and Francesca had bases of $10,000 and $3,000 respectively, and the
partnership did not carry any debt. During the current year, the partnership reported the
following results from operations:
Net sales $650,000

Short-term capital loss $2,000
Tax-exempt interest $2,000
Section 1231 gain $6,000
On the last day of the year, the partnership distributed $3000 each to Lance and Francesca.
a. What outside basis do Lance and Francesca have in their partnership interests at the end
of the year?
b. To what extent does the tax basis limitation apply in restricting the partners’ deductible
losses for the year?
c. To what extent does the passive activity loss limitation apply in restricting their de-
ductible losses for the year?
Lance has an ending basis of $5,000 and Francesca has an ending basis of $0
as illustrated in the table below:
Description Total Lance Francesca Explanation

(Limited) (General)
(1) Partners’ initial $10,000 $3,000Given
Tax basis
Basis Increasing
Items:
(2) Section 1231 $6,000 $3,000 $3,000$6,000 x 50%
gain
20-92
(3) Tax-exempt in- $2,000 $1,000 $1,000$2,000 x 50%

terest
(4) Basis Before $14,000 $7,000Sum of lines (1)
through (3)
Distributions
(5) Cash distribu- ($3,000) ($3,000)Given
tions
(6) Basis Before $11,000 $4,000(4) + (5)
Loss Allocations
Less:
(8) Cost of good (500,000)
sold
(9) Operating ex- (160,000)
penses
(10) Ordinary busi- ($10,000) ($5,000) ($5,000)[Sum of (7) through
(9)] x 50%
ness loss
(11) Short-term ($2,000) ($1,000) ($1,000)($2,000) x 50%
capital loss
Partners’ ending $5,000 $0(6) + (10) + (11) or
tax basis limited to a basis of
zero. Thus, the tax
basis limitation ap-
plies to Francesca.
a. As indicated in the table in part a., Lance’s loss allocations are not
limited by his tax basis; however, Francesca’s total losses are limited
to $4,000—his tax basis prior to his loss allocations.
b. Although Lance’s loss allocations are not limited because of his tax
basis, his share of the ordinary business loss is classified as a passive
activity loss because he is a limited partner. Thus, he must carryover
his $5,000 ordinary business loss as a passive activity loss until he ei-
ther receives passive income or he sells his partnership income. His
$1,000 short-term capital loss is not limited because it is a portfolio
rather than a passive loss. The passive activity loss rules don’t apply
to Francesca because he works full time managing the partnership
and would be classified as a material participant.
20-93
77. [LO 2, 4, 5] LeBron, Dennis, and Susan formed the Bar T LLC at the beginning of the cur-
rent year. LeBron and Dennis each contributed $200,000 and Susan transferred several
acres of agricultural land she had purchased two years earlier to the LLC. The land had a
tax basis of $50,000 and was appraised at $300,000. The land was also encumbered with a
$100,000 nonrecourse mortgage (i.e., qualified nonrecourse financing) for which no one
was personally liable. The members plan to use the land and cash to begin a cattle-feeding
operation. Susan will work full-time operating the business, but LeBron and Dennis will
devote less than two days per year to the operation. All three members agree to split profits
and losses equally. At the end of the first year, Bar T had accumulated $40,000 of accounts
payable jointly guaranteed by LeBron and Dennis and had made a $9,000 principal pay-
ment on the mortgage. None of the members have passive income from other sources.
For the first year of operations, the partnership records disclosed the following information:

Dividends $1,200
Municipal bond interest $300
Salary paid as a guaranteed payment to Susan (not included in expenses) $10,000
Cash distributions split equally among the members at year-end $3,000
a. Compute the adjusted basis of each member’s interest immediately after the formation of
the LLC.
b. When does each member’s holding period for his or her LLC interests begin?
c. What is Bar T’s tax basis and holding period in its land?
d. What is Bar T’s required tax year-end?
e. What overall methods of accounting are available to Bar T?
f. List the separate items of partnership income, gains, losses, deductions and other items
that will be included in each member’s Schedule K-1 for the first year of operations. Use
the proposed self-employment tax regulations to determine each member’s self-employ-
ment income or loss.
g. What are the members’ adjusted bases in their LLC interests at the end of the first year of
operations?
h. What are the members’ at-risk amounts in their LLC interests at the end of the first year
of operations?
20-94
i. How much loss from Bar T, if any, will the members be able to deduct on their individual
returns from the first year of operations?
a. LeBron’s adjusted basis is $216,667, Dennis’ adjusted basis is

$216,667, and Susan’s adjusted basis is $16,667 as calculated in the
table below:
Description LeBron Dennis Susan Explanation

land
(3) Debt allocated to $50,000Nonrecourse
susan only debt > Su-
san’s tax ba-
sis in contrib-
uted proper-
ty
(4) Debt allocated to $16,667 $16,667 $16,667[$100,000 -
partners $50,000] x
33.33%
(5) Relief from nonre- ($100,000)
course mortgage
(6) Gain recognized $0 $0 $0(5 )- [(1)+
(2)+ (3)+
(4)] if posi-
tive, other-
wise 0
(7) Partners’ initial tax $216,667 $216,667 $16,667(1) + (2) +
basis (3) + (4)
+(5)
b. The holding period for LeBron and Dennis begins when they receive
their LLC interests because they only contribute cash. In contrast,
Susan’s holding period includes the holding period for the land he
20-95
contributed since Susan held the land as either a capital or Section

1231 asset.
20-96
c. Bar T receives a $50,000 tax basis in the land and will include Su-
san’s holding period as part of its holding period.
d. Bar T must adopt a calendar year end because all of its members
have calendar year ends.
e. Bar T may adopt either the cash or accrual method of accounting. It

may generally use the cash method because it does not have a cor-
porate member. However, it must use the accrual method in ac-
counting for its inventory related transactions (i.e., the hybrid
method).
The member’s separately stated items are listed on lines (2), (3), (11), and
(13) in the table below. Note that LeBron and Dennis have self-employment in-
come under the proposed regulations because they are responsible for some
Description Total LeBron Dennis Susan Explanation

(1) Members’ Initial Tax $216,667 $216,667 $16,667See part a. above
Basis
(2) Dividends $1,200 $400 $400 $400$1,200 x 33.33%
(3) Municipal bond in- $300 $100 $100 $100$300 x 33.33%
terest
(4) Deemed cash con- $40,000 $20,000 $20,000 Accounts payable
are only allocated
tribution from accounts
to LeBron and Den-
payable nis because they
guaranteed them
(5) Cash distributions ($3,000) ($1,000) ($1,000) ($1,000)
of Bar T’s debt. Susan clearly has self-employment income under the pro-
posed regulations because he works full time in the enterprise.
20-97
(6) Deemed cash distri- ($9,000)Because Susan was

originally allocated
bution to Susan for
the first $50,000 of
mortgage repayment the nonrecourse
mortgage, the re-
payment goes to
reduce her share of
the debt.
(7) Member’s Tax Basis $236,167 $236,167 $7,167Sum of (1) through
(6)
Before Loss Allocation
Less:
(9) Cost of good sold (380,000)
(10) Operating expens- (670,000)
es
(11) Guaranteed pay- (10,000)
ments
(12) Ordinary Business ($440,000) ($146,667 ($146,667 ($146,667[Sum of (8)
through (11)] x
Loss ) ) )
33.33%
(13) Self-employment ($430,000) ($146,667 ($146,667 ($136,667Line (12) +
)
loss ) )$10,000 guaran-
teed payment to
Susan
Members’ ending Tax $89,500 $89,500 $0(7)+ (12) but not
basis less than zero. Su-
san must carry
over $7,167 +
($146.667) or
($139,500) of ordi-
nary loss.
f. As indicated in the table in part f. above, the ending basis for LeBron
is $89,500, the ending basis for Dennis is $89,500, and the ending
basis for Susan is $0.
20-98
g. Generally, the members’ at-risk amounts will be less than the

amount of their tax bases to the extent they are allocated nonre-
course debt that is not qualified nonrecourse financing. In this case,
the members’ at-risk amounts are the same as their tax bases in part
g. because the nonrecourse mortgage is qualified nonrecourse financ-
ing and the accounts payable are treated as recourse debt (i.e., they
are guaranteed by LeBron and Dennis).
h. As indicated in the table in part f. above, the $146,667 loss allocated

to LeBron and Dennis is not limited by their tax bases. However, giv-
en the facts provided, they cannot deduct their losses currently and
each has a $146,667 passive activity loss carryforward because they
are not material participants in the enterprise. As for Susan, her
$146,667 loss is initially limited to her $7,167 tax basis leaving her
with a $139,500 loss carryforward. However, because she is a mate-
rial participant in Bar T, she may deduct the $7,167 currently.
20-99

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Chapter 20 - Forming and Operating Partnerships

2. [LO 1] What types of business entities are taxed as flow-through entities?

The entity concept treats partnerships more align with a corporation.

A partnership interest is an equity interest in a partnership. This interest

In regards to a partnership’s debt, recourse debt is allocated to those

When a partner receives a capital interest in exchange for services ren-

When a partner receives a profit interest in exchange for services ren-

1. Short-term capital gains (losses)

On the partner level, the partner that receives a guaranteed payment

The proposed regulation helped clarify that if an LLC member is involved

Further, regulations help clarify whether a partner would be considered a

4. The activity qualifies as a “significant participation activity” (individ-

5. The individual materially participated in the activity for any 5 of the

a. What is Lance’s tax basis in his LLC interest?

b. What is Lance’s holding period in his interest?

c. What is Cloud Peak’s basis in the contributed property?

d. What is Cloud Peak’s holding period in the contributed property?

Because Lance contributed a capital asset, the holding period of the

a. What is Laurel’s initial tax basis in her LLC interest?

b. What is Laurel’s holding period in her interest?

c. What is Sand Creek’s initial basis in the contributed property?

d. What is Sand Creek’s holding period in the contributed property?

Harry: Basis Fair Market Value

a. How much gain or loss will Harry recognize on the contribution?

b. How much gain or loss will Sally recognize on the contribution?

d. What is Harry’s tax basis in his partnership interest?

e. What is Sally’s tax basis in her partnership interest?

f. What is Evergreen’s tax basis in its assets?

c. Sally should consider selling the property to the partnership rather

g. The partnership’s tax basis balance sheet would appear as follows:

a. How much gain will Cosmo recognize from the contribution?

b. What is Cosmo’s tax basis in his partnership interest?

Description Cosmo Explanation

b. $22,500 as indicated in the table above.

Maude:Basis Fair Market Value

*Nonrecourse debt secured by the land equals $160,000

James, Harold and Jenny each contributed $220,000 in cash.

b. What is Maude’s tax basis in her LLC interest?

d. What is High Horizon’s tax basis in its assets?

Description Maude Other Mem- Explanation

e. High Horizon’s tax basis balance sheet would appear as follows:

High Horizons, LLC

Liabilities and Capital:

Kevan: Basis Fair Market Value

*Nonrecourse debt secured by the land equals $210,000

b. What is Kevan’s tax basis in his LLC interest?

d. What is Albee LLC’s tax basis in its assets?

Description Kevan Other Mem- Explanation

e. Albee, LLC’s tax basis balance sheet would appear as follows:

f. $5,000. See table below:

Description Kevan Jerry Dave Explanation

(5) Gain Recognized $5,000 $0 $0[(1)+ (2)+

g. Kevan’s basis is $0, Jerry’s basis is $385,000, and Dave’s basis is

a. According to Section 1245(b)(3), recapture potential on property con-

b. According to Section 168(i)(7), a transferee partnership will step into

a. According to Section 724(c), recognized losses on assets that were

b. In this instance, Mountainside Developers will recognize a $75,000