Pearsons Federal Taxation 2019

Corporations Partnerships Estates

Trusts 32nd Edition Anderson Test
Bank
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Exam

Name___________________________________

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

1) A partnership cannot recognize a gain or loss on a current distribution. 1)

Answer: True False

2) If a partnership asset with a deferred precontribution gain is distributed within seven years of 2)
acquisition in a nonliquidating distribution to a partner who did not contribute the asset, the
precontribution gain must be recognized by the contributing partner.
Answer: True False

3) In a current distribution, the partner's basis in the partnership interest is reduced by the amount of 3)
money received and by the partnership's bases in the distributed property.
Answer: True False

4) A partner's holding period for property distributed as a current distribution begins on the date of 4)
distribution.
Answer: True False

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

5) A new partner, Gary, contributes cash and assumes a share of partnership liabilities. Diane's 5)
capital, profits, and loss interest in the partnership is reduced by 5% due to the admission of Gary.
The Sec. 751 rules do not apply. Partnership liabilities at the time Gary is admitted are $200,000,
and all of the liabilities are recourse debts for which the partners share the economic risk of loss in
the same way they share partnership profits. Diane's basis in the partnership interest prior to
Gary's admission is $5,000. Due to the admission of Gary, partner Diane has
A) a recognized gain of $5,000 and a partnership interest basis of zero.
B) no recognized gain or loss.
C) no recognized gain or loss and a partnership interest basis of $10,000.
D) a recognized gain of $5,000 and a partnership interest basis of $5,000.
Answer: A

6) If a distribution occurs within ________ years of the contribution date, in a nonliquidating 6)

distribution that does not qualify for Sec. 751 treatment, the distribution event may trigger a
precontribution gain or loss.
A) three B) seven C) five D) unlimited
Answer: B

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 7) Mirabelle contributed land with a $5,000 basis and a $9,000 FMV to MS Partnership four years ago. 7)
This year the land is distributed to Sergio, another partner in the partnership. At the time of
distribution, the land had a $12,000 FMV. How much gain should Mirabelle and Sergio recognize?

A) Mirabelle Sergio B) Mirabelle Sergio

$4,000 $3,000 $5,500 $1,500

C) Mirabelle Sergio D) Mirabelle Sergio

0 0 $4,000 0

Answer: D

8) Mirabelle contributed land with a $5,000 basis and a $9,000 FMV to MS Partnership four years ago. 8)
This year the land is distributed to Sergio, another partner in the partnership. At the time of
distribution, the land had a $12,000 FMV. What is the impact of the distribution on Mirabelle's
partnership basis?
A) 0 B) $7,000 increase C) $4,000 increase D) $4,000 decrease
Answer: C

9) Susan contributed land with a basis of $6,000 and an FMV of $10,000 to the SH Partnership two 9)
years ago to acquire her partnership interest. This year, the land is distributed to Harry when its
FMV is $11,000. No other distributions have been made since Susan became a partner. When the
land is distributed, the partnership's basis in the land immediately before distribution is increased
by
A) $4,000. B) $5,000. C) $1,000. D) $0.
Answer: A

10) Helmut contributed land with a basis of $5,000 and an FMV of $10,000 to the HG Partnership five 10)
years ago to acquire a 50% partnership interest. This year the land is distributed to another partner,
Gail, when its FMV is $11,000. No other distributions have been made since Helmut became a
partner. When the land is distributed to Gail, Helmut recognizes a gain of
A) $5,000. B) $0. C) $2,500. D) $3,000.
Answer: A

11) Becky has a $24,000 basis in her partnership interest. She receives a current distribution of $4,000 11)
cash, unrealized receivables with a basis of $12,000 and an FMV of $16,000, and land held as an
investment with a basis of $3,000 and an FMV of $8,000. The partners' relative interests in the Sec.
751 assets do not change as a result of the current distribution. The basis of her partnership interest
following the distribution is
A) ($4,000). B) $1,000. C) $5,000. D) $0.
Answer: C

12) John has a basis in his partnership interest of $30,000. He receives a current distribution of $6,000 12)
cash, unrealized receivables (FMV $11,000, basis $10,000), inventory (FMV $8,000, basis $4,000),
and investment land (FMV $7,000, basis $6,000). The partners' relative interest in the Sec. 751 assets
do not change as a result of the current distribution. His basis in the land is
A) $7,000. B) $5,000. C) $6,000. D) $10,000.
Answer: C

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13) Danielle has a basis in her partnership interest of $12,000. She receives a current distribution of 13)
$8,000 cash and equipment with a basis of $7,000. There is no potential gain under Sec. 737. What is
her basis in the equipment?
A) $0 B) $7,000
C) $4,000 D) none of the above
Answer: C

14) Identify which of the following statements is true. 14)

A) The partner's basis in the partnership interest is normally reduced by the FMV of property
distributed in a nonliquidating distribution.
B) When a current distribution from a partnership reduces the basis of the partnership interest to
zero, the partner's interest in the partnership is terminated.
C) If a partnership asset with a deferred precontribution gain is distributed in a nonliquidating
distribution to the partner who contributed the asset, the precontribution gain must be
recognized by the partner.
D) All of the above are false.
Answer: D

15) Tenika has a $10,000 basis in her interest in the TF Partnership and no remaining precontribution 15)
gain immediately before receiving a current distribution that consisted of $4,000 in money, plastic
tubes held in inventory with a $3,000 basis to the partnership and an FMV of $3,375, and drip
irrigation pipe held as inventory with a $6,000 basis to the partnership and an FMV of $5,000. What
is the basis in Tenika's hands of the distributed property?
A) $6,000 B) $10,000 C) $10,125 D) $9,000
Answer: A

16) Tenika has a $10,000 basis in her interest in the TF Partnership and no remaining precontribution 16)
gain immediately before receiving a current distribution that consisted of $4,000 in money, plastic
tubes held in inventory with a $3,000 basis to the partnership and an FMV of $3,375, and drip
irrigation pipe held as inventory with a $6,000 basis to the partnership and an FMV of $5,000. What
is Tenika's basis for the plastic tubes and drip irrigation pipe?

A) Plastic Tubes Drip Pipe B) Plastic Tubes Drip Pipe

$3,375 $5,000 $3,000 $5,000

C) Plastic Tubes Drip Pipe D) Plastic Tubes Drip Pipe

$2,250 $3,750 $3,000 $6,000

Answer: C

17) The total bases of all distributed property in the partner's hands following a nonliquidating 17)
distribution is limited to
A) the predistribution FMV of the partner's partnership interest.
B) the FMV of the property distributed.
C) the partner's predistribution basis in his partnership interest.
D) the partnership's bases in the distributed property.
Answer: C

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 18) Carlos has a basis in his partnership interest of $30,000. He receives a current distribution of $6,000 18)
cash, unrealized receivables (FMV $11,000, basis $10,000), inventory (FMV $8,000, basis $4,000),
land held as an investment (FMV $7,000, basis, $6,000), and building (FMV $21,000, basis $9,000).
The partners' relative interests in the Sec. 751 assets do not change as a result of the current
distribution. Carlos's basis in the building is
A) $6,000. B) $9,000. C) $7,500. D) $2,500.
Answer: A

19) Bart has a partnership interest with a $32,000 basis. He receives a current distribution of $6,000 19)
cash, unrealized receivables (FMV $9,000, basis $10,000), inventory (FMV $8,000, basis $4,000),
investment land (FMV $7,000, basis $4,000), and building (FMV $20,000, basis $8,000). No
depreciation recapture applies with respect to the building. The partners' relative interests in the
Sec. 751 assets do not change as a result of the current distribution. Bart's basis in the building is
A) $4,000. B) $3,000. C) $8,000. D) $6,000.
Answer: C

20) Identify which of the following statements is true. 20)

A) The basis for property distributed by a partnership cannot be increased above the carryover
basis amount when it is received by a partner in a nonliquidating distribution.
B) The length of time a partner owns a partnership interest is relevant when determining the
holding period for distributed property.
C) A partner's partnership capital account balance cannot be less than zero.
D) All of the above are false.
Answer: A

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

21) Two years ago, Tom contributed investment land with a basis of $50,000 and an FMV of $62,000 to the RST
Partnership. This year, Tom has a basis in his partnership interest of $53,000 when he receives a current
distribution of $14,000 cash and inventory with a basis of $35,000 and an FMV of $52,000. (There is no Sec. 751
exchange in connection with the inventory distribution.) The partnership continues to hold the land Tom
contributed. How much gain (if any) must Tom recognize as a result of this distribution?
Answer: Precontribution gain = $62,000 - $50,000 = $12,000

Predistribution basis $53,000

Minus: cash distribution ( 14,000)
$39,000

Minus: FMV of distribution other than cash ( 52,000)

Tentative Sec. 737 gain $13,000

Recognized gain = $12,000 [the smaller of precontribution gain ($12,000) or tentative Sec. 737 gain
($13,000)].

22) On November 30, Teri received a current distribution of cash of $4,000, marketable securities with a basis of
$24,000 and an FMV of $30,000, and inventory with a basis of $2,000 and an FMV of $6,000. Prior to the
distribution, Teri's basis in her interest in the partnership was $30,000. (There is no Sec. 751 exchange as a result
of the distribution.) How much gain (if any) must Teri recognize as a result of the distribution?
Answer: Predistribution basis $30,000
Minus: money received (cash and FMV of marketable securities) (34,000)
Gain recognized $ 4,000

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 23) Jerry has a $50,000 basis for his interest in JJ Partnership before receiving a current distribution consisting of
$8,000 in money, accounts receivable having a zero basis to the partnership, and land having a $28,000 basis to
the partnership. What will Jerry's basis be in these assets?
Answer: Generally, the partner's basis for property distributed by the partnership carries over from the
partnership. Jerry will take the carryover basis in the land and receivables.

24) Jerry has a $50,000 basis for his interest in JJ Partnership before receiving a current distribution consisting of
$8,000 in money, accounts receivable having a zero basis to the partnership, and land having a $28,000 basis to
the partnership. What is Jerry's basis in his partnership interest after the distribution?
Answer: Predistribution basis in JJ $50,000
Minus: money received ( 8,000)
carry over basis in A/R (0)
carry over basis in land (28,000)
Postdistribution basis in JJ $14,000

25) When Rachel's basis in her interest in the RST Partnership is $40,000, she receives a current distribution of office
equipment. The equipment has an FMV of $60,000 and a basis of $50,000. Rachel will not use the office
equipment in a business activity. What tax issues should Rachel consider with respect to the distribution?
Answer: • Does Rachel recognize a gain or loss on the current distribution?
• What is Rachel's basis in the office equipment?
• When does Rachel's holding period begin for the property?
• Does any depreciation recapture carry over to Rachel from the partnership?
• What is Rachel's basis in her partnership interest following the distribution?

Rachel recognizes no gain or loss on the distribution. Her basis for the equipment would be a carryover basis
from the partnership ($50,000) if that were possible, but it is limited to her basis in her partnership
interest prior to the distribution ($40,000). Rachel's holding period for the office equipment includes the
holding period the partnership had for the property. Her basis in the partnership interest is zero
following the distribution.

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

26) Under Sec. 751, unrealized receivables include potential Section 1245 or 1250 recapture on the 26)
partnership's depreciable property.
Answer: True False

27) For Sec. 751 purposes, "substantially appreciated inventory" means property held for sale to 27)
customers whose market value exceeds its adjusted basis.
Answer: True False

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

28) Identify which of the following statements is true. 28)

A) Unrealized receivables include rights to payments on the sale of a capital asset.
B) The primary purpose of Sec. 751 is to prevent partnerships from converting capital gains into
ordinary income.
C) If a partner sells property received in a partnership distribution for a gain and the property
was inventory in the hands of the distributing partnership, the partner will always recognize
ordinary income.
D) All of the above are false.
Answer: D

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29) Identify which of the following statements is true. 29)
A) For Sec. 751 purposes, "substantially appreciated inventory" means property held for sale to
customers whose market value exceeds its adjusted basis.
B) Inventory for Sec. 751 purposes includes all property except cash, capital assets, and Sec. 1231
assets.
C) The depreciation recapture potential for a Sec. 1245 property is not included in the definition
of a Sec. 751 asset.
D) All of the above are false.
Answer: B

30) For purposes of Sec. 751, inventory includes all of the following except 30)
A) accounts receivable.
B) items held for sale in the ordinary course of business.
C) capital assets or 1231 property.
D) All of the above are inventory per Sec. 751.
Answer: C

31) The AB Partnership has a machine with an FMV of $25,000 and a basis of $20,000. The partnership 31)
has taken an $8,000 depreciation on the machine. The unrealized receivable related to the machine
is
A) $20,000. B) $0. C) $5,000. D) $8,000.
Answer: C

32) The Internal Revenue Code includes which of the following assets in the definition of Sec. 751 32)
properties?
A) capital assets
B) inventory, which is substantially appreciated
C) cash
D) Sec. 1231 assets
Answer: B

33) The definition of "inventory" for purposes of Sec. 751 includes 33)
A) marketable securities not held by dealers.
B) land held for investment.
C) depreciation recapture potential on Sec. 1231 assets.
D) cash.
Answer: C

34) The definition of "unrealized receivable" does not include the 34)
A) right to payment for services performed by a cash-basis taxpayer.
B) right to payment for services performed by an accrual-basis taxpayer.
C) recapture potential on Sec. 1250 property.
D) recapture potential on Sec. 1245 property.
Answer: B

35) What is the definition of "substantially appreciated inventory"? 35)

A) inventory and unrealized receivables with a FMV greater than their basis
B) inventory and unrealized receivables with a FMV greater than 120% of their basis
C) inventory with a FMV greater than its basis
D) inventory with a FMV greater than 120% of its basis
Answer: B

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36) The ABC Partnership owns the following assets on December 31. 36)

Basis FMV
Cash $20,000 $20,000
Unrealized receivables 0 40,000
Inventory $20,000 30,000
Land (Sec. 1231 asset) 50,000 90,000

The indication that ABC owns substantially appreciated inventory is

A) the FMV of all assets except land is $90,000 while their bases is $40,000.
B) the FMV of the inventory is $30,000 while its adjusted basis is $20,000.
C) the total FMV of all assets except cash is greater than their total basis.
D) the FMV of the inventory and unrealized receivables is $70,000 while their adjusted bases is
$20,000.
Answer: D

37) The XYZ Partnership owns the following assets on December 31: 37)

Basis FMV
Cash $20,000 $20,000
Unrealized receivables 0 15,000
Inventory $30,000 35,000
Land (Sec. 1231 asset) 40,000 70,000

By how much must XYZ reduce its unrealized receivables to avoid meeting the substantially appreciated
inventory test?
A) $10,000
B) $15,000
C) $14,000
D) No amount of reduction of unrealized receivables will affect meeting the substantially
appreciated inventory test.
Answer: C

38) The XYZ Partnership owns the following assets on December 31: 38)

Basis FMV
Cash $10,000 $10,000
Unrealized receivables 0 10,000
Inventory $25,000 30,000

A partner has a 20% interest with a basis of $6,000 in XYZ before receiving a liquidating distribution of
$10,000 cash. XYZ Partnership has no liabilities. His recognized gain is
A) $3,000 ordinary income.
B) $4,000 capital gain.
C) $3,000 ordinary income and $1,000 capital gain.
D) $3,000 capital gain and $1,000 ordinary income.
Answer: C

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ESSAY. Write your answer in the space provided or on a separate sheet of paper.

39) Last year, Cara contributed investment land with an FMV of $24,000 and basis of $18,000 to the CDE
Partnership. CDE made no distributions during last year, and Cara's basis in her partnership interest on
December 31 of last year was $28,000. On January 1 of this year, the partnership distributed cash of $30,000 to
Cara and distributed the land contributed by Cara to another partner, David. On the distribution date, the land
had a $27,000 FMV. Assume the CDE Partnership reported no profit or loss this year. How much gain (if any)
must Cara recognize as a result of the distributions? What is her basis in the partnership after the distributions?
Answer: Cara must recognize a $6,000 capital gain ($24,000 FMV at contribution - $18,000 basis at contribution) on
the distribution of the land to David. The gain recognized increases Cara's basis in her partnership interest.

Cara's predistribution basis $28,000

Plus: precontribution gain recognized 6,000
$34,000

Minus: cash distribution ( 30,000)

Cara's basis after distribution $ 4,000

No income is recognized as a result of the cash distribution.

40) The TK Partnership has two assets: $20,000 cash and a machine having a $28,000 basis and a $40,000 FMV. The
partnership has claimed $16,000 in depreciation on the machine since its purchase. If the machine is sold for its
FMV, would TK Partnership have an unrealized receivable item?
Answer: Yes. All of the $12,000 gain would be an unrealized receivable, since it is recaptured under Sec. 1245.
Primary examples of unrealized receivables are the potential ordinary income recapture items like Sec.
1245 or Sec. 1250.

41) The Tandy Partnership owns the following assets on December 31:

Assets Basis Fair Market Value

Cash $20,000 $ 20,000
Unrealized receivables 0 30,000
Inventory 20,000 25,000
Land, Sec. 1231 property 35,000 70,000
Total $75,000 $145,000

Is the partnership's inventory considered to be substantially appreciated for purposes of Sec. 751? Show your
work.
Answer: For purposes of the substantially appreciated inventory test, both Tandy's unrealized receivables and
inventory are included. The "inventories" FMV of $55,000 exceeds 120% of its adjusted basis, $20,000.
Therefore, the Tandy Partnership has substantially appreciated inventory.

42) What is included in the definition of unrealized receivables?

Answer: Unrealized receivables include not only the obvious cash-method accounts receivable that have yet to be
recognized but also most of the potential ordinary income recapture provisions. Therefore, the term
unrealized receivables is broader than it may appear.

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 43) Do most distributions made by a partnership require a Sec. 751 calculation?
Answer: No. Many current distributions are made pro rate to all partners, so Sec. 751 is not involved. Even if the
distribution is not pro rate, the distribution often does not create an exchange of an interest in Sec. 751
assets for an interest in other assets. This exchange happens only when (1) the partner is reducing his or
her overall interest in the partnership, or (2) an explicit agreement provides that the distribution results
in a partner giving up all or part of his or her interest in some asset(s) maintained by the partnership.

44) Ed receives a $20,000 cash distribution from the EV Partnership, which reduces his partnership interest from
one-third to one-fourth. The EV Partnership is a general partnership that uses the cash method of accounting
and has substantial liabilities. EV's inventory has appreciated substantially since it was purchased. What issues
should Ed consider with regard to the distribution?
Answer: Ed must determine:
• How much is his distribution?
• Does the partnership have Sec. 751 assets?
• If the partnership has Sec. 751 assets, did Ed exchange any interest in Sec. 751 assets for cash?
• How much ordinary income must Ed recognize if he exchanges Sec. 751 assets for cash?
• How must Ed treat any cash distribution received that exceeds the amount deemed to be part of the Sec. 751
exchange?

The amount of the distribution includes both the cash and the relief from liabilities that he received when his
interest in the partnership changed from 1/3 to 1/4. It is likely that the partnership has Sec. 751 assets, since we
know the partnership inventory is substantially appreciated. Further, it is likely that the cash-basis partnership
has unrealized accounts receivable, and the partnership may have recapture potential if it has any
depreciable personalty. Again, it is likely that an exchange of Sec. 751 assets for cash occurred, since Ed
received only cash and probably gave up a portion of his interest (from 1/3 to 1/4) in each Sec. 751 asset.
The amount of ordinary income is the difference between the amount of cash Ed is deemed to have
received for the Sec. 751 assets and the adjusted basis that Ed would have had in the Sec. 751 assets had
the Sec. 751 assets been distributed to Ed immediately before the deemed Sec. 751 sale (usually a
carryover from the partnership's basis in these Sec. 751 assets). Any cash or deemed cash exceeding the
amount deemed to be part of the Sec. 751 exchange is simply treated as a current distribution. The current
distribution will reduce his basis in his partnership interest. If the current distribution is greater than his
basis in the partnership interest, Ed will recognize gain because he receives cash exceeding his basis.

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

45) A partner can recognize gain, but not loss, on a liquidating distribution. 45)
Answer: True False

46) A partner's holding period for a partnership interest is never considered when determining the 46)
holding period for property distributed in a liquidating distribution.
Answer: True False

47) The sale of a partnership interest always results in capital gain or loss rather than ordinary income. 47)
Answer: True False

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MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

48) Identify which of the following statements is true. 48)

A) The rule for recognizing gain on a liquidating distribution is the same rule that is used for a
current distribution.
B) A liquidating distribution that terminates a partnership interest cannot include more than one
distribution.
C) A partnership with a large amount of unrealized receivables and substantially appreciated
inventory items liquidated and distributed all of its assets in kind to each partner in
proportion to their partnership interests. Each partner will report ordinary income at the time
these assets are received equal to their FMV.
D) All of the above are false.
Answer: A

49) Identify which of the following statements is true. 49)

A) The basis of the partnership interest is apportioned between all of the assets received in a
liquidating distribution based on the relative FMVs of the assets.
B) When unrealized receivables are distributed in a liquidating distribution, the basis of the
receivables will be increased.
C) The bases of unrealized receivables and inventory distributed by a partnership in liquidation
of a partnership interest are never increased above their bases in the hands of the partnership.
D) All of the above are false.
Answer: C

50) Ted King's basis for his interest in the Troy Partnership is $24,000. In complete liquidation of his 50)
interest, King receives cash of $4,000 and real property (not a Sec. 751 asset) having an FMV of
$40,000. Troy's adjusted basis for this realty is $15,000. Section 736 does not apply. King's basis for
this realty is
A) $36,000. B) $15,000. C) $20,000. D) $40,000.
Answer: C

51) Derrick's interest in the DEF Partnership is liquidated when his basis in the interest is $30,000. He 51)
receives a liquidating distribution of $20,000 cash and inventory with a basis of $8,000 and an FMV
of $30,000. Derrick will recognize
A) $2,000 ordinary loss.
B) $2,000 capital loss.
C) $10,000 capital loss and $20,000 ordinary loss.
D) no gain or loss.
Answer: B

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52) Before receiving a liquidating distribution, Kathy's basis in her interest in the KLM Partnership is 52)
$30,000. The distribution consists of $5,000 in money, inventory having a $1,000 basis to the
partnership and a $2,000 FMV, and two parcels of undeveloped land (not held as inventory) having
basis of $3,000 and $9,000 to the partnership with FMVs of $5,000 and $12,000, respectively. What is
Kathy's basis in each parcel of land?

A) Parcel One Parcel Two B) Parcel One Parcel Two

$7,059 $16,941 $5,000 $12,000

C) Parcel One Parcel Two D) Parcel One Parcel Two

$6,000 $18,000 $3,000 $9,000

Answer: A

53) Ten years ago, Latesha acquired a one-third interest in Dana Associates, a partnership, for $26,000 53)
cash. This year, Latesha's entire interest in the partnership is liquidated when her basis is $24,000.
Dana's assets consist of the following: cash, $20,000; inventory with a basis of $46,000 and an FMV
of $40,000. Dana has no liabilities. Latesha receives the cash of $20,000 in liquidation of her entire
interest. What is Latesha's recognized loss on the liquidation of her interest in Dana?
A) $4,000 long-term capital loss
B) $4,000 long-term capital loss and $2,000 ordinary loss
C) $4,000 short-term capital loss and $2,000 ordinary loss
D) $0
Answer: A

54) Identify which of the following statements is true. 54)

A) Jake has a basis in his partnership interest of $40,000 before receiving a liquidating
distribution of $5,000 cash, inventory with a basis of $4,000 and an FMV of $5,000, and land
with a basis of $3,000 and an FMV of $6,000. Jake will receive no further distributions. He can
recognize a loss of $28,000 at the time the liquidating distribution is received.
B) On December 31 of the current year, Max Curcio's adjusted basis for his interest in the
Maduro & Motta Partnership is $36,000. Maduro & Motta distributes cash of $6,000 and a
parcel of land held as an investment to Curcio in liquidation of his entire interest in the
partnership. The land has an adjusted basis of $18,000 to the partnership and an FMV of
$42,000. Curcio's basis in the land is $18,000.
C) A partner's holding period for a partnership interest is never considered when determining
the holding period for property distributed in a liquidating distribution.
D) All of the above are false.
Answer: C

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55) Identify which of the following statements is false. 55)
A) When a partnership interest is sold, the buyer and seller can allocate the sale price among the
Sec. 751 assets and non-Sec. 751 assets in any reasonable manner.
B) On June 30 of the current year, James Roe sells his interest in the Roe & Doe Partnership for
$30,000. Roe's adjusted basis in Roe & Doe at June 30 is $7,500 before apportionment of any
partnership income for the current year. The Roe & Doe Partnership uses the calendar year as
its tax year and has no liabilities on June 30. Roe's distributive share of partnership income up
to June 30 is $22,500. Roe acquired his interest in the partnership five years ago. Roe will have
a long-term capital gain on the sale of his interest of $22,500.
C) Section 751 assets include all inventory and all unrealized receivables in a sale or exchange
situation.
D) Statements B and C are true.
Answer: B

56) Kenya sells her 20% partnership interest having a $28,000 basis to Ebony for $40,000 cash. At the time of56)
the sale, the partnership has no liabilities and its assets are as follows:

Basis FMV
Cash $20,000 $20,000
Unrealized receivables 0 40,000
Inventory 10,000 40,000
Land (Sec. 1231) 110,000 100,000

Kenya and Ebony have no agreement concerning the allocation of the sales price. Ordinary income
recognized by Kenya as a result of the sale is
A) $12,000. B) $16,000. C) $6,000. D) $14,000.
Answer: D

57) Steve sells his 20% partnership interest having a $28,000 basis to Nancy for $40,000 cash. At the time of 57)
the
sale, the partnership has no liabilities and its assets are as follows:

Basis FMV
Cash $20,000 $20,000
Unrealized receivables 0 40,000
Inventory 10,000 40,000
Land (Sec. 1231) 110,000 100,000

The receivables and inventory are Sec. 751 assets. There is no agreement concerning the allocation of the
sales price. Steve must recognize
A) $12,000 capital gain.
B) no gain or loss.
C) $12,000 ordinary income.
D) $14,000 ordinary income and $2,000 capital loss.
Answer: D

12
ESSAY. Write your answer in the space provided or on a separate sheet of paper.

58) The CHS Partnership's balance sheet presented below is prepared on a cash basis at September 30 of the current
year.

Assets Basis Fair Market Value

Cash $12,000 $ 12,000
Accounts receivable 0 48,000
Land (capital asset) 63,000 90,000
Total $75,000 $150,000

Equities Basis Fair Market Value

Notes payable $30,000 $ 30,000
Cindy, Capital 15,000 40,000
Helen, Capital 15,000 40,000
Sally, Capital 15,000 40,000
Total $75,000 $150,000

Cindy withdraws from the partnership under an agreement whereby she takes one-third of each of the three
assets and assumes $10,000 of the notes payable. Her basis for the partnership interest before any distribution is
$25,000. What gain/loss should she report for tax purposes?
Answer: No gain or loss is recognized by Cindy or the partnership on the distribution of the Sec. 751 properties,
since Cindy received only her proportionate share of the partnership's assets and liabilities and the
amount of cash deemed distributed ($14,000 = $4,000 cash + $10,000 release from liabilities) is less than
her $25,000 ($15,000 + $10,000 liabilities) basis for the partnership interest.

59) Adnan had an adjusted basis of $11,000 for his interest in the Adnan and Donnell Partnership on December 31.
On this date, Adnan received from the partnership, in complete liquidation of his interest, $10,000 cash and land
with a $2,000 basis to the partnership and a $3,000 FMV. What is Adnan's basis for the land distributed to him?
Answer: $11,000 - $10,000 cash = $1,000 remaining basis. This basis is assigned to the land.

60) Eicho's interest in the DPQ Partnership is terminated when her basis in the partnership is $70,000. She receives a
liquidating distribution of $20,000 cash and inventory with a $24,000 basis and a $40,000 FMV. What is her gain
or loss, and what is her basis in the inventory received?
Answer: She has a recognized loss of $26,000 [($20,000 + $24,000) - $70,000]. Her basis in the inventory she
receives is $24,000.

61) Eicho's interest in the DPQ Partnership is terminated when her basis in the partnership is $70,000. She receives a
liquidating distribution of $20,000 cash and inventory with a $24,000 basis and a $40,000 FMV. She also receives,
as part of the distribution, a desk that has a $100 basis and a $200 FMV to the partnership. What is her gain or
loss, and what is her basis in the items received?
Answer: She does not recognize any loss currently. The bases are computed as follows:

Predistribution basis in DPQ $70,000

Minus: money received ( 20,000)
Basis after money distribution 50,000
Minus: basis of inventory to DPQ ( 24,000)
Remaining basis of partnership interest $26,000

The entire $26,000 is allocated to the desk. This delays the loss recognition until the desk is either depreciated or
sold.

13
62) On December 31, Kate receives a $28,000 liquidating distribution from the KLM Partnership. On that date,
Kate's basis in her limited partnership interest is $18,000 (which, of course, includes her share of partnership
liabilities). The other partners assume her $6,000 share of liabilities. Just prior to the distribution, the
partnership has the following balance sheet. Kate is leaving the partnership but the partnership is continuing.

Assets Basis Fair Market Value

Cash $30,000 $ 30,000
Accounts receivable 0 20,000
Inventory 15,000 25,000
Land 45,000 90,000
Total $90,000 $165,000

Equities Basis Fair Market Value

Notes payable $30,000 $ 30,000
Kate, capital 12,000 27,000
Lynn, capital 24,000 54,000
Mark, capital 24,000 54,000
Total $90,000 $165,000

What is the amount and character of the gain that Kate must recognize on the liquidating distribution?
Answer: Divide the payments between Sec. 736(a) and Sec. 736(b) payments.

Total received ($28,000 + $6,000) $34,000

Minus: FMV of assets (Sec. 736(b)) ( 33,000)
Sec. 736(a) payment - guaranteed payment taxable as ordinary income $ 1,000

Analysis of the Sec. 736(b) payment of $33,000.

Kate is first deemed to receive her share of Sec. 751 assets from the partnership and then immediately sell them
to the partnership for cash.
Sec. 751 Assets
Amount realized - FMV $ 9,000
Minus: adjusted basis (3,000)
Ordinary income $ 6,000

The remaining Sec. 736(b) payment of $24,000 ($33,000 - $9,000 deemed paid for the Sec. 751 assets) is analyzed as
a liquidating distribution.

Predistribution basis in partnership $18,000

Minus: Sec. 751 deemed distribution ( 3,000)
Basis in partnership interest after Sec. 751 transaction $15,000
Minus: remaining Sec. 736(b) distribution ( 24,000)
Excess or capital gain to be recognized $ 9,000

Summary: Kate recognizes a $1,000 guaranteed payment, $6,000 of ordinary income, and a $9,000 capital
gain.

14
63) The HMS Partnership, a cash method of accounting entity, has the following balance sheet at December 31 of
last year:

Assets Basis Fair Market Value

Cash $51,000 $ 51,000
Accounts receivable 0 210,000
Total $51,000 $261,000

Equities Basis Fair Market Value

Notes payable $30,000 $ 30,000
Henry, capital 7,000 77,000
Mark, capital 7,000 77,000
Sam, capital 7,000 77,000
Total $51,000 $261,000

Sam, who has a one-third interest in profits, losses, and liabilities, sells his partnership interest to Beverly, for
$77,000 cash on January 1 of this year. Sam's basis in his partnership interest (which, of course, includes a share
of partnership liabilities) at the time of the sale was $17,000. In addition, Beverly assumes Sam's share of the
partnership liabilities. What is the amount and character of the gain that Sam will recognize from this sale?
Answer: Amount realized = $77,000 + $10,000 liabilities assumed = $87,000.

Realized and recognized gain = $87,000 - $17,000 = $70,000.

The recognized gain is all ordinary income, since it equals his share of the unrealized receivables.

64) On December 31, Kate sells her 20% interest (with a basis of $18,000 which, of course, includes a share of
partnership liabilities) in the KLM Partnership to Karl for $27,000 cash plus assumption of her $6,000 share of
liabilities. On that date, the partnership has the following balance sheet:

Assets Basis Fair Market Value

Cash $30,000 $ 30,000
Accounts receivable 0 20,000
Inventory 15,000 25,000
Land 45,000 90,000
Total $90,000 $165,000

Equities Basis Fair Market Value

Notes payable $30,000 $ 30,000
Kate, capital 12,000 27,000
Lynn, capital 24,000 54,000
Mark, capital 24,000 54,000
Total $90,000 $165,000

What are the amount and character of the gain that Kate must recognize on the sale?
Answer: Total Sec. 751 Assets Other
Amount realized $33,000 $ 9,000 $24,000
Minus: adjusted basis ( 18,000) ( 3,000) ( 15,000)
Recognized gain $15,000 $ 6,000 $ 9,000
Character of gain Ordinary Capital

15
65) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the partnership's
assets are as follows:

Assets Basis Fair Market Value

Cash $80,000 $ 80,000
Unrealized receivables 0 72,000
Inventory 80,000 184,000
Land 80,000 64,000
Total $240,000 $400,000

The partnership has no liabilities on the sale date. Tony's basis in his partnership interest on the date of the sale
is $60,000. What is the amount of gain realized by Tony on the sale of his partnership interest?
Answer: Amount realized on sale $100,000
Minus: adjusted basis of partnership interest ( 60,000)
Total gain realized $ 40,000

66) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the partnership's
assets are as follows:

Assets Basis Fair Market Value

Cash $80,000 $ 80,000
Unrealized receivables 0 72,000
Inventory 80,000 184,000
Land 80,000 64,000
Total $240,000 $400,000

The partnership has no liabilities on the sale date. Tony's basis in his partnership interest on the date of the sale
is $60,000. What is the allocation of Tony's gain to the assets received?
Answer:
Deemed sale of assets Partnership gain (loss) Tony's share (25%)
Unrealized receivables 72,000 18,000
Inventory 104,000 26,000
Land ( 16,000) ( 4,000)

16
67) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the partnership's
assets are as follows:

Assets Basis Fair Market Value

Cash $80,000 $ 80,000
Unrealized receivables 0 72,000
Inventory 80,000 184,000
Land 80,000 64,000
Total $240,000 $400,000

The partnership has no liabilities on the sale date. Tony's basis in his partnership interest on the date of the sale
is $60,000. What are the amount and character of Tony's gain?
Answer:
Deemed sale of assets Partnership gain (loss) Tony's share (25%)
Unrealized receivables 72,000 18,000
Inventory 104,000 26,000
Land ( 16,000) ( 4,000)

Since the unrealized receivables and the inventory are Sec. 751 property, Tony recognizes $44,000 of ordinary
income. The remaining $4,000 loss is a capital loss.

68) Joshua is a 40% partner in the XY Partnership when he sells his entire interest to Stanley for $60,000 cash. At the
time of the sale, Joshua's basis is $36,000, which includes his $10,000 share of partnership liabilities. The
partnership has no Sec. 751 assets. Calculate Joshua's gain or loss on the sale.
Answer: Amount realized:
Cash $60,000
Liabilities assumed by purchaser 10,000 $70,000
Minus: adjusted basis 36,000
Gain recognized on sale $34,000

69) What conditions are required for a partner to recognize a loss upon receipt of a distribution from a partnership?
Answer: A partner can recognize a loss on a distribution only if the distribution is a liquidating distribution that
consists of money, unrealized receivables, and inventory. The partner recognizes a loss if the amount of
money and the carryover basis of the receivables and inventory are less than the partner's predistribution
basis in his or her partnership interest.

70) What is the character of the gain/loss on the sale of a partnership interest?
Answer: Because a partnership interest is generally a capital asset, the sale of a partnership interest results in a
capital gain or loss. However, if a partnership has Sec. 751 assets, the partner is assumed to sell his or her
share of Sec. 751 assets directly with a corresponding ordinary gain or loss being recognized.

71) Can a partner recognize both a gain and a loss on the sale of a partnership interest? If so, under what
conditions?
Answer: A partner must divide the sale of a partnership interest into two transactions if the partnership has Sec.
751 assets. First, the partner is deemed to sell his or her share of Sec. 751 assets for their FMV with their
adjusted bases to the partner, being the basis the Sec. 751 assets would have had if the partner had
received them in a current distribution. The remaining sales proceeds and the remaining adjusted bases
are then considered to be the amounts to be reported from the sale of the remainder of the partnership
interest (non-Sec. 751 assets). Possibly, one part of the transaction could generate a loss while the other
part could generate a gain.

17
 72) David sells his one-third partnership interest to Diana for $60,000 when his basis in the partnership interest is
$48,000. On the date of sale, the partnership has no liabilities and the following assets:

Assets Basis FMV

Cash $40,000 $40,000
Inventory 18,000 27,000
Building 75,000 102,000
Land 11,000 11,000

The building is depreciated on a straight-line basis. What tax issues should David and Diana consider with respect
to the sale transaction?
Answer: • Does the partnership have Sec. 751 assets?
• What is the amount and character of the gain on the sale of David's partnership interest?

There are no unrealized receivables, but the partnership does have inventory. David's gain is calculated as
follows:
Assets
Total Sec. 751 Other
Amount realized $60,000 $9,000 $51,000
Minus: adjusted basis (48,000) ( 6,000) (42,000)
Recognized gain $12,000 $3,000 $ 9,000

The gain attributable to the Sec. 751 assets is ordinary while the remainder of the gain is capital.

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

73) When a retiring partner receives payments that exceed the value of that partner's partnership 73)
property, the excess payment is a guaranteed payment.
Answer: True False

74) Under the check-the-box rules, an LLC with more than one member is taxed as a partnership 74)
unless it elects to be taxed as a corporation.
Answer: True False

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

75) Identify which of the following statements is true. 75)

A) An exchange of partnership interests in different partnerships qualifies under the like-kind
exchange rules.
B) John Albin is a retired partner of Brill & Crum, a personal service partnership. Albin has not
rendered any services to Brill & Crum since his retirement six years ago. Under the provisions
of Albin's retirement agreement, Brill & Crum is obligated to pay Albin 10% of the
partnership's net income each year through the end of the current year. In compliance with
the agreement, Brill & Crum pay Albin $25,000 in the current year. Albin should treat this
$25,000 as a long-term capital gain.
C) The payment for partnership property to a retiring partner is not deductible by the
partnership and often not income to the retiring partner.
D) All of the above are false.
Answer: C

18
76) For tax purposes, a partner who receives retirement payments ceases to be regarded as a partner 76)
A) on the day on which the partner retires.
B) on the last day of the month in which the partner retires.
C) on the last day of the taxable year in which the partner retires.
D) only after the partner's last payment is received.
Answer: D

77) If a partnership chooses to form an LLC, under the check-the-box rules, and assuming no elections 77)
are made, the entity will be taxed as
A) a C corporation.
B) an S corporation.
C) a partnership if it has more than one member.
D) Unable to determine from the facts presented.
Answer: C

78) Identify which of the following statements is true. 78)

A) The partnership's tax year closes with respect to a partner whose interest is transferred by gift.
B) An LLC has been taxed as a partnership for five years. Under the check-the-box rules, the
LLC makes a timely election in 2009 to be taxed as a C corporation. The election of C
corporation status is permitted and results in the LLC's assets being transferred from a
partnership to a C corporation under the federal income tax rules.
C) Under the check-the-box rules, an LLC with more than one member is taxed as a corporation
unless it elects to be taxed as a partnership.
D) All of the above are false.
Answer: B

79) If a partner dies, his or her tax year closes 79)

A) on the day before death. B) on the day after death.
C) on some other date. D) on the date of death.
Answer: D

80) A partnership terminates for tax purposes 80)

A) when at least 50% of the total interest in partnership capital and profits changes hands by sale
or exchange within twelve consecutive months.
B) only when it terminates under local partnership law.
C) when a partnership tax return (Form 1065) ceases to be filed by the partnership.
D) when the sale of partnership assets is made only to an outsider(s) and not to an existing
partner(s).
Answer: A

81) Marc is a calendar-year taxpayer who owns a 30% capital and profits interest in the MN 81)
Partnership. Nancy sells the remaining 70% capital and profits interest to Henry on October 31. The
partnership year-end is March 31 as permitted by the IRS for business purpose reasons. The MN
Partnership
A) terminates on October 31. B) terminates on December 31.
C) does not terminate. D) terminates on March 31.
Answer: A

19
82) A partnership terminates for federal income tax purposes if 82)
A) within a 12-month period, there is a sale or exchange of at least 50% of the total interest in
partnership capital and profits.
B) a general partner who owns a majority interest dies.
C) state partnership law terminates the partnership.
D) a partnership interest of more than 50% is gifted.
Answer: A

83) Identify which of the following statements is true. 83)

A) When the interest of a partner who owns 60% of a partnership is completely liquidated by a
partnership distribution, the partnership is considered terminated, even though three other
partners remain.
B) The partnership tax year closes when a partner transfers his interest by gift.
C) If a partner dies in a two-member partnership, the partnership terminates on the date of
death, even though the successor-in-interest continues to share in the profits and losses of the
partnership business.
D) All of the above are false.
Answer: D

84) Identify which of the following statements is false. 84)

A) A partner's individual income tax return, under some circumstances, may include the results
of partnership operations for a period exceeding 12-months.
B) When several different transfers are made during a 12-month period, the partnership
termination occurs on the date of the transfer that first crosses the 50% threshold.
C) When using the 50% rule to terminate a partnership, if an interest is sold more than once
during the 12-month period, each sale is counted separately.
D) A sale or exchange of at least 50% of the capital and profits interest in a partnership within a
12- consecutive-month period will terminate the partnership and end all of the partnership's
elections.
Answer: C

85) Sally is a calendar-year taxpayer who owns a 30% capital and profits interest in the SEM 85)
Partnership. Eric sells the remaining 70% capital and profits interest to Michelle on October 3. The
partnership year-end is March 31 as permitted by the IRS for business purposes. Which of the
following statements is correct?
A) Sally must conform her tax year with the partnership tax year.
B) The new partnership is a continuation of the old partnership.
C) Sally's tax return will include partnership distributive shares for periods ending March 31
and October 3.
D) Sally's tax return will include a partnership distributive share only for the period ending
March 31.
Answer: C

20
86) The LM Partnership terminates for tax purposes on July 15 when Latasha sells her 60% capital and 86)
profits interest to Zoe for $100,000. The partnership has no liabilities, and its assets at the time of
termination are as follows:

Assets Basis FMV

Cash $ 20,000 $ 20,000
Receivables 10,000 12,000
Inventory 22,000 28,000
Building 80,000 85,000
Land 30,000 21,667
Total $162,000 $166,667

Marika, a 40% partner in the LM Partnership, has a $64,800 basis in her partnership interest (outside basis)
at the time of the termination. She has held her LM Partnership interest for three years at the time of the
termination. The bases of Marika and Zoe in the new LM Partnership is:

A) Marika Zoe B) Marika Zoe

$66,667 $100,000 $66,667 $ 97,200

C) Marika Zoe D) Marika Zoe

$64,800 $ 97,200 $64,800 $100,000

Answer: D

87) The AB, BC, and CD Partnerships merge into the ABCD Partnership. AB (owned by Austin and 87)
Ben) contributes assets worth $100,000. BC (owned by Ben and Charlie) contributes assets worth
$200,000. CD (owned by Charlie and Dennis) contributes assets worth $300,000. The capital and
profits interest in ABCD is owned by: Austin, 10%; Ben, 30%; Charlie, 25%; and Dennis, 35%. ABCD
Partnership is a continuation of
A) CD. B) BC.
C) AB. D) none of the partnerships.
Answer: A

21
ESSAY. Write your answer in the space provided or on a separate sheet of paper.

88) Rod owns a 65% interest in the RRR Partnership, a general partnership, which he sells to the two remaining
partners - Roger and Regis. The three partners have agreed that Rod will receive $160,000 in cash from the sale.
Rod's basis in the partnership interest before the sale is $125,000, which includes his $35,000 share of
partnership recourse liabilities. The partnership has assets with a $310,000 FMV and a $210,000 adjusted basis.
What issues should Rod, Roger, and Regis consider before this sale takes place?
Answer: Roger and Regis should consider the following:
• The sale as contemplated will terminate the partnership. Is termination of the partnership desirable for Roger
and Regis?
• Will either individual have to recognize a gain? The recognition of gain is unlikely unless Roger and Regis
have a small basis relative to the cash held by the partnership and deemed distributed in the liquidating
distribution.
• What will be the basis for each of the assets? Under current Treasury Regulations, the termination will be
deemed to result in the old partnership contributing the property directly to the new partnership so that no
adjustment to asset bases is likely to occur.
• Will income be bunched into a single tax year if the partnership terminates? Termination of the partnership
closes a tax year. If the partnership has the same tax year-end as Roger and Regis, no bunching of income will
occur. If their tax years differ, however, some bunching will occur.
• When the partnership terminates, all elections are lost. Are there advantages or disadvantages from losing all
existing elections? There are a few advantageous tax year-ends for old partnerships that were grandfathered
when Congress enacted the rules about required partnership tax year-ends. The loss of this tax benefit
would be a significant disadvantage.
• Would liquidation by the partnership be more advantageous than a sale to the other partners? Liquidation
by the partnership cannot terminate the partnership.

Rod should consider:

• How much of his gain from the sale would be considered as a sale from his interest in Sec. 751 assets and,
therefore, taxed as ordinary income? His sale will result in ordinary income to the extent the FMV of Sec. 751
assets exceeds the adjusted basis in those assets that Rod would have had if the assets had been distributed to Rod
just before he sold his interest in the partnership.
• Will the sale cause a bunching of income from the partnership for Rod? Since the sale of the entire
partnership interest closes the partnership tax year for the selling partner, the sale will cause bunching of
income if Rod's tax year-end is different from RRR's tax year-end.
• Could the transaction be structured in such a way that a liquidation by the partnership would be more
beneficial to Rod? Possibly. If Roger and Regis really do not want the partnership to terminate, they may be
willing to pay Rod more in a liquidating distribution than they were willing to pay for an outright purchase.

89) Quinn and Pamela are equal partners in the QP Partnership. On December 30 of the current year, the QP
Partnership agrees to liquidate Quinn's partnership interest for a cash payment on December 30 of each of the
next five years. What tax issues should Quinn and Pamela consider with respect to the liquidation of Quinn's
partnership interest?
Answer: • Does the partnership terminate for tax purposes?
• If so, when does the termination occur?

The partnership terminates since only one partner remains. The partnership terminates when the final Sec. 736
payment is made.

22
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

90) Han purchases a 25% interest in the CHOP Partnership from Huang for $600,000. The partnership 90)
has assets with a basis of $1,600,000. What is the amount of the basis adjustment, if the partnership
has a 754 election in place?
A) $200,000 increase in Han's share of the basis in partnership assets
B) $150,000 increase in Han's basis in his partnership interest
C) $1,000,000 increase in partnership assets
D) $0
Answer: A

91) Patrick purchases a one-third interest in the PPP partnership for $600,000. The partnership has 91)
assets with a value of $1,500,000. PPP has a 754 election in effect. What is the amount of the basis
adjustment?
A) $100,000 increase in Patrick's basis in the partnership assets
B) $100,000 increase in Patrick's share of the basis in the partnership assets
C) $0
D) $300,000 increase in the basis of partnership assets
Answer: B

92) Which of the following statements is correct? 92)

A) The Sec. 754 election applies to both sales and distributions.
B) A partnership can revoke a Sec. 754 election every 5 years.
C) The Sec. 754 election applies to only current and nonliquidating distributions.
D) A partnership may make an annual election to adjust the basis of its assets upon the sale of a
partnership interest.
Answer: A

93) When must a partnership make mandatory basis adjustments? 93)

A) on any sale of a 20% or greater partnership interest
B) on any sale of a partnership interest where the partnership's adjusted basis in its assets
exceeds their fair market value by $250,000 or more
C) on any sale of a partnership interest for $250,000 or more
D) on any distribution of assets with a value of $250,000 or more
Answer: B

94) Which of the following is a valid reason for making a 754 election? 94)
A) A partnership can reduce its basis in assets upon cash distributions to partners.
B) Partnerships can increase, but not decrease, their basis in partnership assets.
C) Partners are able to increase their basis in the partnership interest upon the sale of a
partnership interest.
D) An incoming partner pays more for a partnership interest that his or her proportionate share
of partnership assets.
Answer: D

23
 95) Patrick purchased a one-third interest in the PPP partnership for $600,000. At the time of the 95)
purchase, the partnership had a 754 election in effect and its only asset was land with a basis of
$1,500,000. This year, PPP sells the land for $1,800,000. What is Patrick's recognized share of the
gain on the sale of the land?
A) $0 B) $300,000
C) $100,000 D) none of the above
Answer: A

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

96) Sean, Penelope, and Juan formed the SPJ partnership by each contributing assets with a basis and fair market
value of $200,000. In the following year, Penelope sold her one-third interest to Pedro for $225,000. At the time of
the sale, the SPJ partnership had the following balance sheet:

Basis FMV
Cash $200,000 $200,000
Land $400,000 $475,000
$600,000 $675,000

Shortly after Pedro became a partner, SPJ sold the land for $475,000. What are the tax consequences of the sale to Pedro
and the partnership (1) assuming there is no Section 754 election in place, and (2) assuming the partnership has a valid
Section 754 election?
Answer: (1) The partnership has a $75,000 gain ($475,000 - $400,000) and $25,000 of this gain is allocated to Pedro.
(2) Pedro's share of the basis of the land is increased by $25,000, the amount that he paid for the
partnership interest in excess of the basis of the partnership assets. This basis increase is allocated entirely
to the land. The partnership still has a $75,000 gain on the sale of the land, but Pedro's $25,000 share is
eliminated by the 754 adjustment to the basis of the land (1/3 × 475,000) - [(1/3 × 400,000) + 25,000] = 0.

97) What are some advantages and disadvantages of making a Section 754 election?
Answer: Advantages: Without a 754 election, if a new partner purchases a partnership interest when the
partnership assets have a fair market value greater than their basis, the partner will be taxed on his/her
proportionate share of any gain on a subsequent sale of these assets in addition to paying a higher
purchase price for the partnership interest due to the assets' appreciation. The partner will not be able to
recover this "double taxation" until the partnership is liquidated, which may be several years in the future. Sec.
754 prevents this timing problem by adjusting the partner's basis in partnership assets.

The Sec. 754 election has several disadvantages, including increased recordkeeping. Partners and/or the
partnership must maintain separate records showing the calculation and allocation of the basis
adjustment. Once a 754 election is made, adjustments are required on all subsequent sales and
distributions, even if the adjustment decreases the basis. For distributions, the basis adjustment belongs
to the partnership as a whole. The 754 election can only be revoked with IRS approval.

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

98) A limited liability company is a form of business entity that combines the legal benefits of the 98)
corporate form with the tax benefits of the partnership form.
Answer: True False

24
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

99) Identify which of the following statements is true. 99)

A) A limited liability company is a form of business entity that combines the legal benefits of the
corporate form with the tax benefits of the partnership form.
B) A partnership is "publicly traded" only if its interests are traded on an established securities
exchange.
C) When a partnership is divided into two or more new partnerships, all of the resulting
partnerships must be considered new partnerships.
D) All of the above are false.
Answer: A

100) The STU Partnership, an electing Large Partnership, has no passive activities and reports the 100)
following transactions for the year: net long-term capital losses $50,000, Sec. 1231 gain $60,000,
ordinary income $20,000, charitable contributions $15,000, and tax-exempt income $2,000. How
much will be reported as ordinary income to its partners?
A) $22,000 B) $5,000 C) $20,000 D) $17,000
Answer: D

101) The STU Partnership, an electing Large Partnership, has no passive activities and reports the 101)
following transactions for the year: net long-term capital losses $50,000, Sec. 1231 gain $60,000,
ordinary income $20,000, charitable contributions $15,000, and tax-exempt income $2,000. How
much will be reported as long-term capital gains to its partners?
A) $0 B) $50,000 C) $60,000 D) $10,000
Answer: D

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

102) What are the advantages of a firm being formed as a limited liability company (LLC) instead of as a limited
partnership?
Answer: From a legal standpoint, all the owners of a limited liability company (LLC) have limited liability for the
firm's debts. In a limited partnership, all general partners have significant liability for firm debts. Under
the check-the-box regulations, an LLC can choose whether to be taxed as a partnership or as an
association taxed as a corporation. If the LLC chooses partnership taxation, there is virtually no difference
between the taxation of the LLC and the limited partnership.

103) The limited liability company (LLC) has become a popular business form because of its limited liability
protection for its owner. The S corporation also provides limited liability protection for its owner. What
advantages does an LLC provide that are not available with an S corporation?
Answer: • The LLC is taxed as a partnership under the check-the-box rules. As such, the basic operating restrictions
that are imposed on an S corporation do not apply to an LLC. These include, but are not limited to: a 100
shareholder limit; restrictions on the type of eligible shareholders; a single class of stock; and the limitation on
amount of passive income that can be earned by an S corporation.
• The corporate-level taxes imposed on an S corporation, such as the built-in gains tax and excess net
passive income tax, do not apply to an LLC.
• The loss limitation is larger for an LLC than for an S corporation because of the treatment of general debts
incurred by the LLC under the partnership taxation rules.
• All states have enacted LLC laws, so that the problem with a lack of developed legal structure for handling
general legal problems has disappeared. The application of basic legal principles to S corporations was no
problem since in most cases they followed the basic rules for corporations.

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104) What is an electing large partnership? What are the advantages to the partnership of electing to be taxed under
the electing large partnership rules?
Answer: An electing large partnership is a partnership that is not a service partnership, is not engaged in
commodity trading, has at least 100 partners, and files an election to be taxed as an electing large
partnership. The primary advantage to the partnership of electing to be an electing large partnership is
that the reporting of income to the large number of partners is simplified. Relatively few items are
separately stated so that the reporting process is more difficult than a corporation but easier than a
nonelecting partnership.

105) All states have adopted laws providing for limited liability companies. Describe a limited liability company
(LLC).
Answer: An LLC often combines the legal benefits of a corporation with the tax benefits of a partnership. Whether
an LLC is characterized as a corporation or a partnership for federal tax purposes depends on the number
of corporate characteristics that are present. An LLC should be treated as a partnership if it has the
centralized management and limited liability characteristics of a corporation, but does not have the free
transferability of interest or continuity-of-life characteristics. If treated as a partnership, they offer more
flexibility than an S corporation in that there is no limit on the number of shareholders, the number of
classes of stock that can be outstanding, or the types of investments in related entities that can be made.
The increased flexibility being written into some of the state LLC laws concerning the various corporate
characteristics has resulted in the LLCs created in certain states being treated as corporations or
partnerships, depending upon the terms of the LLC's organizing document. However, the IRS
implemented a system that allows LLCs to designate via a check-the-box mechanism whether they wish
to be taxed as a partnership or as a corporation. It is anticipated that most new LLCs will desire to be
taxed as a partnership (their default treatment) when they have two or more owners.

106) Brown Company recently has been formed as a limited liability company (LLC). Brown Company is owned
equally by three individuals Gene, Susan, and Sandra all of whom have substantial income from other
sources. Brown is a manufacturing firm and expects to earn approximately $130,000 of ordinary income and
$30,000 of long-term capital gain each year for the next several years. Gene will be a full-time manager and will
receive a salary of $60,000 each year. What tax issues should the owners consider regarding the LLC's initial
year of operations?
Answer: • Should Brown choose to be taxed as a partnership or as a corporation?
• How much will be kept in the business for growth, and how much will be distributed to the owners each
year? The larger the percentage of earnings that will be distributed, the more advantageous a flow-through
entity such as a partnership can be.
• What is the marginal tax rate for Gene, Susan, and Sandra? If Gene, Susan, and Sandra have lower marginal
tax rates than does Brown, partnership status has advantages.
• How should Gene's pay for operating the business be structured? If the business is taxed as a corporation, a
generous but reasonable salary will decrease the amount of income subject to double taxation. If the business
is structured as a partnership, the partners need to decide whether to structure the payment as
distributive share, as an outright guaranteed payment, or whether to establish a guaranteed minimum
that may be some combination of the two.

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107) The Principle Limited Partnership has more than 300 partners and is publicly traded. The Principle was
grandfathered under the 1987 Tax Act and has consistently been taxed as a partnership. In the current year, The
Principle Limited Partnership will continue to be very profitable and will continue to pay out about 30% of its
income to its owners each year. The managing partners of The Principle want to consider the firm's options for
taxation in the current and later years.
Answer: What method should The Principle Limited Partnership choose to use to operate under the publicly
traded partnership rules?

• Pay the annual 3.5% of gross income tax and continue to be taxed as a publicly traded partnership?
• Buy back enough interests (or restrict opportunities for trading) so that the partnership is no longer publicly
traded?
• Incorporate the entity and be taxed as a regular (C) corporation?

The best alternative will be a function of the amount of gross income, amount of taxable income, tax rates of the
partners, amount of profits the firm wants to retain, and costs of buying back partnership interests, and/or
restricting trading, or incorporating.

If The Principle Limited Partnership chooses to continue as a partnership, should it elect to come under the
electing large partnership rules?
• The election reduces the partnership's annual cost of providing information to partners but will require
some start-up cost to make the change. The election also has the advantage of making it more difficult to
accidentally terminate the partnership because of trades. However, the election significantly reduces the
partners' reporting and audit options.

108) There are no questions for this section.

Answer:

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