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Chapter C:9
Partnership Formation and Operation
Discussion Questions
C:9-1 Advantages of a partnership for Yvonne and Larry include:

1. The partnership itself is not subject to tax, thereby eliminating the problem of double
taxation that exists for C corporations. p. C:9-4.
2. Partners may divide the partnership's profit or loss among themselves without regard
to their proportionate capital interests (as long as the allocation has substantial economic effect).
pp. C:9-17 through C:9-20.
3. Partnerships are popular because of the relative simplicity and informality inherent in
creating and operating such entities. No legal agreement is required to form a partnership but a
written agreement is advisable. p. C:9-2.
4. Under the conduit principle of taxation, partnership losses and other items receiving
special tax treatment flow through to the partners. p. C:9-4.
C:9-2 Lack of limited liability. A corporation provides limited liability protection for the business
owners while a general partnership does not. The purchase of the inn is likely to be financed with
debt and additional debt is likely to be incurred during the renovations. The construction required
during the renovation and the day-to-day operation of the inn provides significant exposure for
liability from lawsuits. The partnership form would not protect the owners of the business from
possibly losing their individual assets. If the owners want the advantages of a partnership and still
have limited liability, they may want to consider a limited liability company (LLC) or a limited
liability limited partnership (LLLP) if available in the taxpayer’s state. pp. C:2-3 through C:2-6 and
C:9-2 through C:9-4.
C:9-3 General partnership. Because Sam will be providing business advice, this partnership should
be arranged as a general partnership. Both brothers will be actively managing the business and
therefore limited liability protection would not be available to Sam if the partnership is created as a
limited partnership with Sam as the limited partner. The brothers, however, also may want to
consider an LLC instead of a partnership. pp. C:9-2 through C:9-4.
C:9-4 Whether Doug receives a profits interest or a capital and profits interest; he theoretically
should report the value of the property he receives for services as ordinary income. In this case, the
initial basis for his partnership interest equals the amount he reports as income. If the profits
interests cannot be valued, however, Doug recognizes no income and has a zero basis in his
partnership interest. Also, under Rev. Proc. 93-27, 1993-2 C.B. 343, the IRS will not treat receipt of
a profits interest as a taxable event unless one of the following events occurs: (1) the profits interest
relates to a substantially certain and predicable income stream, (2) the partner disposes of the interest
within two years of receipt, or (3) the interest is a publicly traded partnership. (Note: The IRS is in
the process of revising its rules concerning service partners. See Notice 2005-43, 2005-24 C.B.
1221.) pp. C:9-10 through C:9-12.
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

C:9-1
C:9-5 a. Probably not. The existing partner could contribute the property tax-free to the
partnership, but Sec. 704(c) requires that the tax attributes from contributed property be allocated to
the partner that contributes the property. Under Sec. 704(c), the partners must specially allocate
among themselves the income, gain, loss, and deductions attributable to contributed property in a
manner that reflects the difference between the property's FMV and its tax basis at the time of the
contribution. In addition, the partnership will have the property with a carryover basis, which is
below its FMV. For depreciable assets, the partnership will get smaller depreciation deductions and
the special allocation of depreciation among the partners may not totally compensate the other
partners. pp. C:9-5 through C:9-12 and C:9-18 through C:9-20.
b. Sell or lease the property to the partnership or sell the property to a third party who
then contributes the property to the partnership. pp. C:9-27 and C:9-28.
c. Ordinary income recognition is required on a partner's sale of property to the
partnership where the seller owns more than 50% of the capital or profits interests if the property is
either depreciable, or is not a capital asset, in the hands of a partnership. If the partner leases
property to a partnership, the partner retains the depreciation and other deductions with respect to the
property. The leasing partner also avoids the depreciation recapture provisions. Rentals received
from the partnership are taxed as ordinary income. A sale of the property to a third party is taxed as
any other sale would be with no special tax consequences. pp. C:9-27 and C:9-28.
C:9-6 a. The partner recognizes gain on the contribution of property and assumption of a
liability if the amount of the liability assumed by the other partners exceeds the contributing
partner's basis in the contributed property plus her share of existing partnership liabilities. pp. C:9-5
through C:9-8.
b. Net decrease. The basis in the partnership interest will be decreased by the amount of
the liability assumed by the other partners. Viewed another way, her basis will increase by her share
of the increase in partnership liabilities and decrease by her liability assumed by the partnership, for
a net decrease. pp. C:9-6 through C:9-8.
C:9-7 a, b, and d. p. C:9-12.
C:9-8 No. Partnership ordinary income is the total of partnership income and deduction items that
do not have to be separately stated. This partnership has $100,000 of ordinary income. Partnership
taxable income, however, is the sum of all taxable items that are either separately stated or included
in ordinary income. BW’s partnership taxable income is $150,000 ($100,000 ordinary income +
$50,000 long-term capital gain). p. C:9-17.
C:9-9 The partner's distributive share will equal the sum of the partner’s earnings for one-half of
his or her beginning-of-the-year interest for the entire year and the partner’s earnings for the other
one-half of his or her beginning-of-the-year interest for nine months (calculated on a daily basis).
pp. C:9-18 and C:9-19.
C:9-10 Usually no because a limited partner normally has no economic risk for recourse debt.
However, a limited partner's basis is increased by recourse liabilities to the extent the limited partner
is liable to incur an economic loss, for example, to the extent he or she is obligated to repay a

C:9-2
general partner should the general partner have to pay the debt or to the extent the limited partner
has guaranteed the debt. pp. C:9-21 through C:9-24.
C:9-11 Qualified nonrecourse real estate financing is included in the at-risk basis of both general and
limited partners. This financing meets the requirements for qualified nonrecourse real estate
financing. p. C:9-26.
C:9-12 Less restrictive. Section 704(d) limits the loss to the adjusted basis (before reduction by
current year's losses) of a partner's interest in the partnership at the end of the partnership tax year in
which the loss occurs. This basis includes recourse debt (to the extent of a partner’s economic risk
of loss) and includes nonrecourse debt. The at-risk basis does not include nonrecourse debt (other
than qualified nonrecourse real estate financing). Thus, the at-risk rules are more restrictive than the
Sec. 704(d) rule. p. C:9-26.
C:9-13 No. As a limited partner in the JRS Partnership, Jeff is almost certainly subject to the passive
loss limitation rules on losses from this partnership. Accordingly, income from a general partnership
in which Jeff materially participates (and thus earns active income) cannot be used to offset the
passive losses. Jeff can use losses from the JRS Partnership only to offset passive income, or he can
claim the losses when he sells his entire interest in the JRS Partnership or when the partnership
terminates. pp. C:9-26 and C:9-27.
C:9-14 Contribute the property. ABC Partnership will hold the land as inventory for resale to
customers and not as a capital asset. Because Helen owns more than a 50% interest in the ABC
Partnership, the sale of the land to the partnership will generate ordinary income instead of capital
gain for Helen. If Helen instead contributes the land to the partnership, it will recognize no gain
until it sells the lots. Then, as the partnership sells each lot, Helen will recognize the precontribution
gain as well as her share of any postcontribution appreciation, and all the gain will be ordinary
income taxable at a marginal rate of up to 35%. In total, the ordinary income under this alternative
will be the same as if Helen had sold the land to the partnership. A contribution, however, will
allow her to delay the gain recognition. Even better results occur if Helen can dispose of 5% or
more of her partnership interest so that she owns, directly and indirectly, 50% or less of the ABC
Partnership. If she owns 50% or less, she can recognize capital gain on the sale of the land to the
partnership and use these gains to offset any capital losses she already may have recognized or that
she may desire to recognize. The capital gains are taxed to most taxpayers at a maximum marginal
tax rate of 15% or up to 20 percentage points below the rate applicable to ordinary income.
Alternatively, she could sell the land to a third party who would then contribute the land to the ABC
Partnership, assuming the partnership desires a new partner. Her gain on the sale of the land would
be capital gain, and the contributing partner would recognize no gain when he or she transferred the
land to the partnership. pp. C:9-27 and C:9-28.
C:9-15 A guaranteed amount is stated as a fixed dollar amount regardless of the partnership's income
or loss. A guaranteed minimum can be determined only after the profitability of the partnership's
operations has been determined. A guaranteed minimum may be paid partly out of the partner's
distributive share and partly as a guaranteed payment, which total to the amount of the guaranteed
minimum. pp. C:9-28 and C:9-29.

C:9-3
C:9-16 Yes. Regulation Sec. 1.707-1(c) provides that a partner reports guaranteed payments as
ordinary income in the partner's tax year that includes the last day of the partnership's tax year in
which the partnership deducted the payments under its method of accounting. A partner reports his
or her distributive share of partnership items (determined under Sec. 702(a)) in the tax year that
includes the last day of the partnership's tax year. Thus, from a timing perspective, the two
payments schemes are the same to Tracy. pp. C:9-28 and C:9-29.
C:9-17 The Sec. 704(e) rules apply only to a capital interest in a partnership, where capital is a
material income producing factor and where the family member is the true owner of the interest. If
capital is a material income-producing factor for the partnership, the family partnership rules apply.
p. C:9-30.
C:9-18 The distributive shares allocated to Andrew and Steve will be combined and then a
reasonable salary for Andrew's personal services will be allocated to him. The remaining portion of
the distributive share (after a reasonable salary to Andrew) will be allocated 30/50ths to Andrew and
20/50ths to Steve. p. C:9-30.
Issue Identification Questions
C:9-19 • Does Bob recognize any gain on the formation? When will he recognize the
precontribution gain?
• What is Bob's basis and holding period for his partnership interest?
• Does Kate recognize any loss on the contribution of property in exchange for her
partnership interest? When will she recognize the precontribution loss? What will
the character of the loss be?
• What is Kate's basis and holding period for the partnership interest she received in
exchange for property?
• What basis and holding period does the partnership have in the property received?
• What are the Sec. 1250 ramifications for the building?
• What type of gain will the partnership and partners recognize on the sale of the
building?
• Did Kate receive any of her partnership interest for services?
• If so, what gain, loss, or deductions must the partnership recognize?
• What income must Kate recognize?
Bob must determine his basis in the partnership interest ($65,000 = $95,000 - $60,000 +
$30,000 share of liabilities) and his holding period for his interest in the partnership (begins with his
ownership of the office building). Because Bob recognizes no gain or loss, he does not have to be
concerned with any recapture potential under Sec. 1250. Also, Sec. 1250 recapture will not be a
concern if the parties have depreciated the property under straight-line MACRS rules. Bob,
however, will have to recognize precontribution gain on the office building at a future date. This
gain will be part Sec. 1250 gain subject to the 25% capital gains tax rate under Sec. 1(h)(l)(D) and
part Sec. 1231 gain subject to the 15% capital gains tax rate. As mentioned, if the building is
straight-line MACRS property, no ordinary depreciation recapture will occur.

C:9-4
Kate must determine her basis in the partnership interest ($105,000 = $75,000 + $30,000
share of liabilities) and her holding period for her interest in the partnership (begins with her
ownership of the land). (Also see discussion of services in the last paragraph of this solution.) Kate
recognizes no loss at the time of the partnership formation. If the land was a capital asset to Kate
and the partnership sells the land within five years of Kate's contribution, the loss will be a capital
loss up to $25,000, and that capital loss will be allocated to Kate as a precontribution loss. After five
years, the character of the loss will be determined by the character of the land to the partnership, but
Kate still will have to report any precontribution loss recognized. Guaranteed payments will be
reported as ordinary income.
The partnership must be concerned with the basis and holding period of the assets it receives
(carryover for both basis and holding period). The partnership can deduct from ordinary income the
guaranteed payments made to Kate.
An additional tax issue must be addressed. Bob contributed property with a net value of
$70,000 for a one-half interest in the partnership while Kate contributed property with a net value of
only $50,000 for a one-half interest in the same partnership. The total partnership has a net value of
$120,000 ($130,000 + $50,000 - $60,000 liability). One possibility is that Bob has made a $10,000
gift to Kate. If so, both partners’ bases must be adjusted to reflect the gift. Alternatively, the facts
suggest that Kate may be receiving some of her partnership interest in exchange for her services in
managing the business for the first year while receiving no guaranteed payment. If so, Kate must
recognize ordinary income and increase her basis for the value of the partnership interest she
received in exchange for services. If Kate is receiving some of her partnership interest for services,
the partnership must recognize gain or loss on the partnership assets she is deemed to receive and
must adjust the basis of the assets for her deemed recontribution. The partnership also must deduct
the guaranteed payment. (Note: The IRS is in the process of revising its rules concerning partners
who contribute services. See Notice 2005-43, 2005-24 C.B. 1221.) pp. C:9-5 through C:9-12, C:9-
28, and C:9-29.
C:9-20 • What items qualify as organizational expenditures, which are start-up expenditures,
and what items can be deducted currently?
• Does the partnership want to deduct (up to $5,000) and then amortize organizational
expenditures and/or start-up expenditures? If so, over what time period does the
amortization occur (if applicable)?
• When does the partnership business begin?
The partnership first must characterize each expenditure as an organizational expenditure, a

start-up expenditure (Chapter C:3), another expenditure to be capitalized, or a current period
expense. The costs of drawing up the partnership agreement and of establishing the accounting
system are organizational expenditures (totaling $3,200). The cost of searching for a retail outlet is a
start-up expenditure ($1,600), and the cost of having an income statement prepared is a current
period expense ($500).

C:9-5
The partnership then must decide how it wants to handle the organizational and start-up
expenditures. Because each of these items is less than $5,000, the partnership can elect to deduct the
expenditures currently under Sec. 195 for the start-up expenditures and under Sec. 709 for the
organizational expenditures. If the expenditures had exceeded $5,000 each, the partnership would
amortize the balances over 180 months.
Another issue the partnership must face is when is the partnership is considered to begin
business. Regulation Sec. 1.709-2(c) states that business begins when the partnership "starts the
business operation for which it was organized." Had the expenditures exceeded $5,000,
amortization of both the excess organizational expenditures and the excess start-up expenditures
would begin with the month in which business begins. p. C:9-12.
C:9-21 • Is the receipt of a profits interest in the ABC Partnership in exchange for Cara's
services a taxable event?
• If it is a taxable event, what is the amount and character of the income recognized?
• What is Cara's basis and holding period for her partnership interest?
The receipt of the partnership interest is not a taxable event. Under Rev. Proc. 93-27, 1993-2
C.B. 343, the receipt of a profits interest is taxable only under circumstances where the FMV of the
interest can be readily determined. This situation does not fit into one of the three exceptions
contained in the revenue procedure guidelines as being a taxable event. (Note: The IRS is in the
process of revising its rules concerning partners who contributed services. See Notice 2005-43,
2005-24 C.B. 1221.) pp. C:9-10 through C:9-12.
C:9-22 • What is George's basis in his partnership interest?

• Does the repayment of the partnership liability cause an adjustment to George's basis
in his partnership interest?
• Is the repayment of the nonrecourse liability a taxable event for George? If so, what
is the amount and character of the income reported?
Repayments of partnership liabilities are treated as distributions to the partners. A

distribution made to a partner that exceeds his or her basis for the partnership interest produces a
taxable gain. The gain can be calculated as follows:
Basis at the beginning of the year $15,000

Plus: George's share of income
(0.20 x $20,000) 4,000
George's basis before the distribution $19,000
Minus: George's deemed distribution from
repayment of partnership liability
(0.20 x $100,000) (20,000)
George's recognized gain $ 1,000

C:9-6
After these adjustments, George’s basis in the partnership interest is zero. Also, the gain is a capital
gain if the “distribution” is deemed proportionate (see Chapter C:10).
C:9-23 • What is Katie's deductible loss from her partnership investment?

• What is Katie's Sec. 704(d) basis in her partnership interest?
• What is Katie's at-risk basis in her partnership interest?
• Is the loss from the JKL Partnership a passive loss?
• Does Katie have passive income from this investment or other investments?
• If so, can she deduct her losses?
• If not, do the losses carryover to later years?
As a limited partner, Katie is presumed not to materially participate in the partnership.

Therefore, because the loss is from a passive activity, she cannot deduct it unless she has passive
income from other investments, or she terminates her interest in the limited partnership. If no such
income exists, the losses carry over to later years. pp. C:9-26 and C:9-27.
C:9-24 • Do the family partnership rules apply when no family relationship exists?
• Does reasonable compensation need to be paid to Daniel for his services?
• If so, what is reasonable compensation for Daniel's services?
• Does David need to be recognized as a partner in the CD Partnership?
• If so, what is David's allocable share of the partnership income?
• What is Daniel's allocable share of the partnership income?
The family partnership rules are written in terms of the donor-donee relationship.
Accordingly, they apply in this situation. Both Daniel and David would be allocated a reasonable
compensation amount. Then, the remainder of the income originally allocated to Daniel and David
would be reallocated to them based on their relative capital interests. p. C:9-30.
Problems
C:9-25 a. Neither partner recognizes gain or loss (Sec. 721).
b. Suzanne Bob
Basis of contributed property $59,000 $95,000
Minus: Partnership assumption
of individual liabilities (80,000)*
Plus: Share of partnership liabilities 40,000 40,000*
Basis in partnership $99,000 $55,000
*Alternatively, Bob reduces his basis by $40,000 ($40,000 - $80,000), which is the amount of his
liability assumed by the other partners.

C:9-7
c. The partnership takes a carryover basis in each asset: inventory (securities), $14,000;
land, $45,000; and building, $50,000.
d. The partnership’s initial book value is each asset’s FMV at the time of contribution:
inventory, $15,000; land, $40,000; and building, $100,000.
e. Amount realized $20,000
Minus: Adjusted basis ( 14,000)
Realized gain $ 6,000
Precontribution gain of $1,000 ($15,000 FMV at contribution - $14,000 basis) is allocated to

Suzanne. Bob and Suzanne share the remaining $5,000 gain equally. Thus, Suzanne reports $3,500
of gain, and Bob reports $2,500 of gain. The gain is ordinary (and not capital) because the property
was inventory to Suzanne and because the partnership sold the inventory within five years of its
contribution. pp. C:9-5 through C:9-10 and C:9-21 through C:9-24.
C:9-26 a. Fred recognizes ordinary income (compensation) of $15,000. Ed recognizes $89,000

(calculated in Part c below) of Sec. 1231 gain. The other partners recognize no gain or income.
b. The partnership recognizes no gain, loss, or income on the transfers.
c. Al: Cash contribution $ 15,000

Mortgage allocated to partner 19,500
Basis of partnership interest $ 34,500
Bob: Accounts receivable basis to Bob $ -0-

Clay: Equipment basis to Clay $ 13,000

Dave: Land basis to Dave $ 50,000

Ed: Building basis to Ed $ 15,000

Mortgage contributed to partnership* (130,000)
Mortgage allocated to partner* 26,000
Tentative basis (and amount of gain recognized) $ 89,000
Actual basis (basis cannot be less than zero) $ -0-
*Or minus $104,000 ($130,000 - $26,000) mortgage assumed

by other partners

C:9-8
Fred: Services contributed by Fred $ 15,000
d. Bases: cash, $15,000; accounts receivable, $0; equipment, $13,000; land, $50,000;
building, $15,000; and organizational expenditures, $15,000.
e. Book values: cash, $15,000; accounts receivable, $20,000; equipment, $15,000; land,
$15,000; building, $150,000; and organizational expenditures, $15,000.
f. The building has no depreciation recapture potential because straight-line MACRS
depreciation has been used. However, part or all of a subsequent gain will be classified as Sec. 1250
gain subject to the 25% capital gains tax rate under Sec. 1(h)(l)(D) at the partner level. The
depreciation recapture potential for the office equipment carries over to the partnership. The
partnership will recognize the recapture when it sells or exchanges the property in a taxable
transaction.
g. If Fred's profits interest had an ascertainable value, the result is unchanged. If the
profits interest has no ascertainable value at the time of the transaction, Fred recognizes no income,
and the partnership has no organizational expenditure for which an amortization deduction can be
claimed. Also, under Rev. Proc. 93-27, 1993-2 C.B. 343, the IRS will not treat receipt of a profits
interest as a taxable event unless one of the following events occurs: (1) the profits interest relates to
a substantially certain and predicable income stream, (2) the partner disposes of the interest within
two years of receipt, or (3) the interest is in a publicly traded partnership. (Note: The IRS is in the
process of revising its rules concerning partners who contributed services. See Notice 2005-43,
2005-24 C.B. 1221.)
h. Partnership: Amount realized on sale $ 9,000
Minus: Adjusted basis ( 50,000)
Recognized loss ($41,000)
Dave: Fair market value when contributed $15,000

Minus: Adjusted basis 50,000
Precontribution loss ($35,000)
Total loss $41,000
Minus: precontribution loss ( 35,000)
Postcontribution loss $ 6,000
Precontribution loss $35,000
Plus: Share of postcontribution
loss (0.15 x $6,000) 900
Dave's distributive share of loss $35,900
Other Partners: Postcontribution loss allocated

to other partners ($6,000 - $900) $ 5,100
Each partner can claim his share of the $5,100 loss only when he has sufficient basis in his
partnership interest. pp. C:9-5 through C:9-12, C:9-18, C:9-24, and C:9-25.

C:9-9
C:9-27 a. Julie and Kay recognize no income on the partnership formation. Susan recognizes
ordinary income equal to the value of the partnership interest received, or $20,000. (Note: The IRS
is in the process of revising its rules concerning partners who contributed services. See Notice
2005-43, 2005-24 C.B. 1221.)
b.
Julie Kay Susan

Basis of property contributed $ -0- $75,000 N/A
Plus: Share of liabilities 16,200 32,400* $ 5,400
Minus: Liabilities assumed by partnership _______ (54,000)*
Plus: Income recognized (for services) $16,200 _______ 20,000
Basis in partnership $53,400 $25,400
*Or minus $21,600 ($54,000 - $32,400) liabilities assumed by other partners.
Basis Book Value
c. and d. Accounts receivable $ -0- $ 60,000

Land 30,000 58,000
Building 45,000 116,000
Organizational expenditure 20,000 20,000
e. All of Kay’s precontribution gain is allocated to her, and no postcontribution gain
remains to be allocated to other partners.
Kay’s gains are analyzed as follows: Land Building
Cash received $40,000 $ 80,000

Plus: Liability assumed by buyer 18,000 36,000
Amount realized $58,000 $116,000
Minus: Adjusted basis ( 30,000) ( 45,000)
Gain realized and recognized $28,000 $ 71,000
Character of gains:
Sec. 1250 gain* $ -0- $ 15,000
Sec. 1231 gain 28,000 56,000
Total $ 28,000 $ 71,000
*The Sec. 1250 property is not subject to depreciation recapture because of straight-line
depreciation, but to the extent of depreciation taken, the gain is Sec. 1250 gain subject to the 25%
capital gains tax rate under Sec. 1(h)(l)(D).
pp. C:9-5 through C:9-12, and C:9-19.

C:9-10
C:9-28 a. Sean reports $75,000 of ordinary income and has a $75,000 basis in his partnership
interest. The partnership deducts $75,000 as compensation, allocating the deduction to the old
partners (none to Sean). The partnership (and the remaining partners) also recognize gains and
losses as if 20% of each asset had been sold at its FMV to pay for Sean's services. The basis in each
asset having a gain (or loss) related to it will be adjusted upward (or downward) by the amount of
the gain (or loss) recognized. In addition, the $100,000 of current year ordinary income is allocated
as follows under the varying interest rule:
Old partners: (100% x 334/365 x $100,000) + (80% x 31/365 x $100,000) = $98,301

Sean: 20% x 31/365 x $100,000 = $1,699
b. Under Sol Diamond, 33 AFTR 2d 74-852, 74-1 USTC ¶9306 (7th Cir., 1974), if an
ascertainable FMV exists for the interest, such value must be reported as income by Sean and is
deductible by the XYZ Partnership. However, if the 20% interest has no ascertainable FMV, neither
Sean nor the XYZ Partnership has any current tax consequences except that the $100,000 ordinary
income is allocated as in Part a. In addition, under Rev. Proc. 93-27, 1993-2 C.B. 343, the IRS will
not treat receipt of a profits interest as a taxable event unless one of the following events occurs:
(1) the profits interest relates to a substantially certain and predicable income stream, (2) the partner
disposes of the interest within two years of receipt, or (3) the interest is in a publicly traded
partnership. (Note: The IRS is in the process of revising its rules concerning partners who
contributed services. See Notice 2005-43, 2005-24 C.B. 1221.) pp. C:9-10 through C:9-12 and
C:9-18.
C:9-29 Marjorie: Income: $15,000 ($20,000 FMV of interest - $5,000 cash)

Basis in partnership interest: $15,000 income recognized + $5,000 cash
contributed + Marjorie's share of partnership liabilities (not given in
problem).
Eldorado: Capitalizes the $15,000 as part of the capital raised by the partnership. This
amount is a syndication fee and cannot be deducted now nor amortized in the
future as an organizational expenditure. The $5,000 cash contribution
increases the partnership's assets. Marjorie's capital account includes
$15,000 + $5,000, or $20,000.
(Note: The IRS is in the process of revising its rules concerning partners who contributed services.
See Notice 2005-43, 2005-24 I.R.B. 1221.)

C:9-11
C:9-30 a.
Possible Tax Year-Ends
6/30 9/30 10/31
Partner Partnership Tax Months Months Months

Name Interest Year Deferred Total Deferred Total Deferred Total
Beta 1/3 6/30 0 .00 9 3.00 8 2.67

Chi 1/3 9/30 3 1.00 0 .00 11 3.67
Delta 1/3 10/31 4 1.33 1 .33 0 .00
2.33 3.33 6.34
The partnership must use a June 30 year-end, or with a Sec. 444 election, a tax year that ends
on March 31, April 30, or May 31.
b. The natural business year that ends on January 31.
c. The partnership would be required to use an October 31 year-end, or the tax year of
the majority partner. Alternatively, with IRS permission, the partnership could use a natural
business year-end (January 31), or with a Sec. 444 election, the partnership could use a tax year that
did not exceed a three-month deferral of income. pp. C:9-12 through C:9-15.
C:9-31 a. December 31. The tax year-end of majority partners Boris and Damien is December 31,
making this the required year-end for the partnership.
b. Yes. Possible year-ends are those that allow for no more than a three-month deferral
from the required December 31 year-end. These year-ends include September 30, October 31, and
November 30. pp. C:9-12 through C:9-15.
C:9-32 Solution appears on next page.

C:9-12
C:9-32 a. and b.
Mark Pamela
Partnership ordinary income items:
Sales $450,000
Minus: Cost of goods sold (210,000)
Gross profit $240,000
Plus: Sec. 1245 gain 33,000
Minus: Ordinary expenses:
Depreciation $27,000
Guaranteed payment 30,000
Business interest 42,000
Meals and entertainment (50%) 5,800 (104,800)
Partnership ordinary income $168,200 $ 84,100 $ 84,100
Separately stated items:

Dividend income $ 15,000 $ 7,500 $ 7,500
T-E interest income 4,000 2,000 2,000
Sec. 1231 gain 18,000 9,000 9,000
Net long-term capital gain ($12,000 - $10,000) 2,000 1,000 1,000
Short-term capital loss (9,000) (4,500) (4,500)
Investment interest expense (9,200) (4,600) (4,600)
Charitable contributions (5,000) (2,500) (2,500)
Nondeductible M&E expense (5,800) (2,900) (2,900)
Nondeductible interest on loan for T-E interest (2,800) (1,400) (1,400)
Guaranteed payment 30,000
c. Mark Pamela*
Beginning basis in partnership interest $150,000 $150,000

Plus: Partnership ordinary income 84,100 84,100
Dividend income 7,500 7,500
T-E interest income 2,000 2,000
Sec. 1231 gain 9,000 9,000
Net long-term capital gain 1,000 1,000
Minus: Distributions (40,000) (40,000)
Reduction in partnership liabilities (7,000) (7,000)
Short-term capital loss (4,500) (4,500)
Investment interest expense (4,600) (4,600)
Charitable contributions (2,500) (2,500)
Nondeductible M&E expense (2,900) (2,900)
Nondeductible interest on loan for T-E interest __(1,400) __(1,400)
Ending basis in partnership interest $190,700 $190,700
*Note: Pamela’s basis calculation does not reflect the guaranteed payment because the increase
for recognition and the decrease for payment net to zero. pp. C:9-16 through C:9-25.

C:9-13
C:9-33
(a) (b) (c) (d)

Financial Taxable Ordinary Separately
Transaction Income Income Income Stated Items
Income
Operating profit $ 94,000 $ 94,000 $ 94,000 $ 31,000
Rental income 30,000 31,000a 15,000
Interest on municipal bonds 15,000 3,000
Interest on corporate bonds 3,000 3,000 20,000
Dividend 20,000 20,000 66,000c
Gain on investment land 60,000 66,000b 10,000
LTCG 10,000 10,000 ( 7,000)
STCL ( 7,000) ( 7,000) 9,000
Sec. 1231 gain 9,000 9,000 44,000
Unrecaptured Sec. 1250 gain 44,000 44,000
Expenses (12,000)
Depreciation ( 39,000) ( 41,000)d ( 29,000)
Interest:
Mortgage ( 18,000) ( 18,000) ( 18,000)
Mun. bond loan ( 5,000) ( 5,000)
Guaranteed payment ( 30,000) -0-e ( 30,000) 30,000
Total $186,000 $ 211,000 $35,000
a
Prepaid rental income is reported for tax purposes when it is received.
b
For financial accounting purposes, the book value of the land was $15,000 and generated a book
gain of $60,000. The tax basis was $6,000 smaller, so the tax gain is $6,000 larger.
c
The precontribution gain of $6,000 ($15,000 - $9,000) must be specially allocated to Jim while the
postcontribution gain of $60,000 ($66,000 total gain - $6,000 precontribution gain) is allocated
ratably to all three partners.
d
MACRS depreciation is used for tax purposes.
e
The guaranteed payment has no net effect on taxable income. The guaranteed payment both
reduces ordinary income and increases separately stated income items that are taxable.
Each partner will be notified of his share of low-income housing expenditures qualifying for the
credit. pp. C:9-16 through C:9-21.

C:9-14
C:9-34 a.
Partner
Items Total Becky Chuck Dawn
Ordinary income $120,000 $24,000 $36,000 $60,000

Long-term capital gain 18,000 3,600 5,400 9,000
Short-term capital loss 6,000 1,200 1,800 3,000
Charitable contribution deduction 20,000 4,000 6,000 10,000
b.
Partnership Becky’s Becky's Chuck’s Chuck's

Total % Amount % Amount
1/1 through 6/30a

Ordinary income $59,507 20% $11,901 30% $17,852
LTCG 8,926 20% 1,785 30% 2,678
STCL 2,975 20% 595 30% 893
Charitable contribution 9,918 20% 1,984 30% 2,975
7/1 through 12/31b

Ordinary income $60,493 25% $15,123 25% $15,123
LTCG 9,074 25% 2,269 25% 2,269
STCL 3,025 25% 756 25% 756
Charitable contribution 10,082 25% 2,521 25% 2,521
a
1/1 through 6/30 is 181 days in a non-leap year.
b
7/1 through 12/31 is 184 days in a non-leap year.
pp. C:9-18 and C:9-19.
C:9-35 Patty:
Ordinary income: $ 3,200 (0.40 x $8,000)
Long-term capital gain:
Precontribution 6,000 ($10,000 - $4,000)
Postcontribution 1,600 [0.40 x ($14,000 - $10,000)]
Total income/gain $10,800
Dave reports $4,800 ($8,000 x 0.60) of ordinary income and $2,400 ($4,000 x 0.60) of long-term
capital gain. p. C:9-19.

C:9-15
C:9-36 As stated in text Example C:9-25, the allocation meets the first test of shifting because the
partners’ capital accounts increase by $10,000 whether with the special allocation or with an equal
allocation. The following calculations show the tax effects of the two allocations:
Special allocation: Andy Becky Total
Taxable interest income $ -0- $10,000

Tax-exempt interest income 10,000 -0-
Total allocation $10,000 $10,000
Taxable income $ -0- $10,000

Times: Tax rate 0.35 0.15
Tax liability $ -0- $ 1,500 $1,500
Equal allocation: Andy Becky Total
Taxable interest income $ 5,000 $ 5,000

Tax-exempt interest income 5,000 5,000
Total allocation $10,000 $10,000
Taxable income $ 5,000 $ 5,000

Times: Tax rate 0.35 0.15
Tax liability $ 1,750 $ 750 $2,500
Thus, shifting occurs because the special allocation does not alter the partners’ capital accounts and
because the special allocation reduces the partners’ total tax liability. Therefore, the special
allocation lacks substantiality. pp. C:9-19 through C:9-21.
C:9-37 a. No. This special allocation does not meet the test of having substantial economic
effect and will not be acceptable to the IRS. In particular, shifting occurs because the special
allocation does not alter the partners’ capital accounts, and the special allocation reduces the
partners’ total tax liability by shifting enough short-term capital gain to Clark to offset his entire
short-term capital loss.
b. The special allocation affects only the partners’ tax consequences and not the
economic consequences. Each partner's distributive share is still $100,000. Accordingly, the special
allocation will not be accepted, and the income must be allocated according to the partners' 50/50
interest in the partnership. The partners must report the following:
Total Clark Lois
Short-term capital gain $ 60,000 $30,000 $30,000

Ordinary income 140,000 70,000 70,000

C:9-16
C:9-38 a. The special allocation could have substantial economic effect in Year 1 but not in
Year 2 or Year 3 because Diane does not have an obligation to repay negative capital account
balances.
b. The special allocation will have substantial economic effect in all three years.
c. As in Part a, the special allocation will not have substantial economic effect in Year 2
or Year 3 because Diane will have a negative capital account balance in each year. The liability
increases basis but does not increase her capital account. pp. C:9-19 through C:9-21.
C:9-39 a. Carryover basis of contributed property $14,000

Minus: Debt assumed by other partners (0.80 x $10,000) ( 8,000)
Partnership interest basis $ 6,000
b. Carryover basis from friend $34,000

Plus: Share of partnership liabilities 20,000
Partnership interest basis $54,000
c. The interest's FMV used in valuing the estate ($120,000) is Kelly's basis. pp. C:9-21
through C:9-24.
C:9-40 a. The FMV of the partnership interest, or $25,000.

(Note: The IRS is in the process of revising its rules concerning partners who
contributed services. See Notice 2005-43, 2005-24 C.B. 1221.)
b. Land basis $ 6,000
Car basis 15,000
Cash contributed 2,000
Share of recourse liabilities (0.40 x $100,000) 40,000
Basis in partnership interest $63,000

C:9-17
C:9-41 a. Purchase price $ 50,000
Plus: Share of liabilities (0.40 x $200,000) 80,000
Distributive share of taxable items ($30,000 +
$10,000 - $1,000) 39,000
Distributive share of tax-exempt items ($8,000 - $2,000) 6,000
Minus: Change in liabilities (0.40 x $20,000) ( 8,000)
Basis on December 31 $167,000
b. Purchase price $ 50,000

Plus: Share of recourse liabilities (0.30 x $200,000) 60,000
Distributive share of taxable items 39,000
Distributive share of tax-exempt items 6,000
Increase in nonrecourse liabilities (0.40 x $80,000) 32,000
Minus: Reduction in recourse liabilities (0.30 x $100,000) ( 30,000)
c. Purchase price $ 50,000

Plus: Distributive share of taxable items 39,000
Distributive share of tax-exempt items 6,000
Increase in nonrecourse liabilities (0.40 x $80,000)* 32,000
*Tina has no economic risk of loss for the recourse liabilities
and therefore receives no basis for these liabilities.
C:9-42 a. and b.
Analysis of Outside Basis and At-Risk Basis:
Kerry City Corporation
Outside basis at January 1 $200,000 $200,000

Plus: Short-term capital gain 150,000 150,000
Partnership nonrecourse liability 50,000 50,000
Outside basis before losses $400,000 $400,000
Minus: Reduction for losses (see below) ( 400,000)a ( 400,000)
Outside basis after losses $ -0- $ -0-
At-risk basis before losses $350,000 N/A

Minus: Reduction for losses (350,000)
At-risk basis after losses $ -0-

C:9-18
Treatment of Losses: Kerry City Corporation
Losses:
Ordinary loss $450,000 $450,000
Long-term capital loss 50,000 50,000
Total $500,000 $500,000
Loss allowed $350,000a $400,000b
Character of losses allowed:

Ordinary loss (450/500 x loss allowed) $315,000 $360,000
Long-term capital loss (50/500 x loss allowed) 35,000 40,000
Total $350,000 $400,000
a
Kerry’s loss is limited to his at-risk basis. Nevertheless, his outside basis is reduced by $400,000.
b
City Corporation is not subject to the at-risk rules because it is not closely held. Thus, the
corporation’s loss is limited to its outside basis.
c. The qualified nonrecourse liability is considered to be at-risk. Therefore, both

partners can deduct a $400,000 loss and have a zero outside basis for their partnership interest after
the year’s operations. Thus, City Corporation’s results are the same as in Parts a and b, and Kerry’s
results are now the same as City’s. p. C:9-26.
C:9-43
Gary (General Partner-60%) Mary (General Partner-40%)

Tax Basis At-Risk Basis Tax Basis At-Risk Basis
Beginning basis without debt $ 42,000 $42,000 $28,000 $28,000

Recourse debt (accts. pay.) 18,000 18,000 12,000 12,000
Nonrecourse debt 60,000 -0- 40,000 -0-
Basis before losses $120,000 $60,000 $80,000 $40,000
Operating loss* (120,000) (60,000) (80,000) (40,000)
Ending basis $ -0- $ -0- $ -0- $ -0-
*Gary recognizes a $60,000 loss, and Mary recognizes a $40,000 loss, both limited by the at-
risk rules. Nevertheless, Gary and Mary reduce their partnership bases by the full amount of the
losses. They can deduct the disallowed losses in future years if they increase their at-risk bases.
p. C:9-26.

C:9-19
C:9-44 a.
Eve Tom
Beginning basis $46,000 $75,000

Plus: Share of LTCG 8,000 12,000
Basis before loss $54,000 $87,000
Share of loss $56,000 $84,000
Limitations on loss $54,000 $87,000

Sec. 704(d) limit 54,000 87,000a
At-risk limit N/A 12,000b
Passive activity limit
Deductible loss $54,000 $12,000
a
Because the partnership has no nonrecourse liabilities, the at-risk basis equals the
partnership basis for both partners. Thus, the at-risk rules do not limit the losses the partners
can deduct.
b
Eve materially participates in the partnership business, so the partnership's ordinary loss is
an active loss for her. Tom is a limited partner and does not materially participate, so his
deduction for losses is limited to the passive income he earns from this (and all other)
passive activities during this year. Because the problem states that he has no other income
except his salary, Tom can deduct the loss only to the extent of his share of income from this
partnership. This result assumes that the long-term capital gain relates to the partnership’s
operations and is not portfolio income. These rules determine the amount of loss Tom can
deduct. The character (and the treatment of Tom's income on the tax return) remains
$12,000 ordinary loss and $12,000 long-term capital gain.
b. The additional $100,000 recourse debt would increase both the Sec. 704(d) basis and
the at-risk basis for Eve, who has the economic risk of loss. This increase would give her enough at-
risk basis to deduct her full $56,000 distributive share of partnership losses. As a limited partner,
Tom would have a basis increase only if he had some agreement to assume an economic risk of loss
related to the recourse borrowings. Even if he had a basis increase (which is unlikely), Tom could
not deduct any additional loss because the passive activity loss rules still limit passive losses to
passive income.
pp. C:9-26 and C:9-27.

C:9-20
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Indian Court of First Mesa District
Judge Hooker was a figure in the First Mesa community. At one time he
had been a Hopi of the Hopi, and had fought the new system of schools
and school regulation with all his crude ability. To prevent his children
from being enrolled, he had walled them up at home; that is, he placed
them in a small room of his house, gave them food and water, and then
walled up the entrance door, hoping that his fresh mortar would not
arouse suspicion. To-day he is hated by pagans because he has tried to
assimilate the doctrines of Christianity, and is looked on by some
Christians as an arch-hypocrite. Such are the trials of the savage.
Actually he is a childish old fellow who has tried to merit the confidence of
the mission folk, with little concept of where paganism ends and
Christianity begins. His greatest [133]sacrifice in life has been the
abandonment of tribal ceremonies. From his house below the mesa can
be seen the famous Walpi dance-ledge, like a miniature stage high in the
thin air, thronged on pagan festal days with multi-colored costumes,
where faintly sound the chanting and the drums. But he never attends
these feasts of rhythm and song, save at the biennial Walpi Snake
Dance, when he joyfully receives a dispensation from the Agent to go as
an official of the Government, he being a Judge and the authorized Crier.
Many times did he cry down the aimless chatter of tourists during my
administration, that solemn announcements might be made to the
brethren and the visitors cautioned against the making of vile
photographs and unseemly levity. Garbed in a magnificently beaded
waistcoat that had decked some long-vanquished Sioux warrior, and
bearing his staff of office, a knotted club out of Africa, he presents a
strange and not undignified figure on these occasions.
Therefore the two who shared the woolsack were contrasts. Hostin Nez,
a Navajo pagan of the pagans, a Medicine Man, a leader of chants and a
priest of the sand-paintings; Hooker Hongave, a simple-minded savage
who had turned halfway toward the Church, with the low-toned booming
of hide drums in his ears, and in his heart perhaps a longing for the
mysticism of his ancient people.
The day of hearing having been reached, and all assembled, the Judges
listened to the story of old broken Greeley, who had by no means
recovered and was still swathed in bandages. The accused was a burly
fellow under forty, powerful enough to have challenged a middleweight,
who did not deny or extenuate the assault.
“It is a very bad thing this man has done,” said Judge Hooker, clucking
his tongue and shaking his head sadly. [134]
“Yes, my brother,” agreed the Navajo jurist. “It is a serious thing and it
must not happen again. We must make an example of this man so all the
people may know of it.”
“We will,” said Hooker; and they withdrew to frame up a sentence.
From their determined expressions I feared that friend prisoner would get
at least a year in the hoosegow—an embarrassing piece of business, for
the Regulations do not recognize any charge as deserving more than
ninety days, and the Territorial Court had thought three years sufficient
for cold-blooded murder in a recent Indian case. The judges reappeared.
“He is a bad man,” said Hooker.
“Yes, he is a dangerous fellow,” said Hostin Nez.
“And so we will send him to jail for—ten days.”
“Ten days!” I cried out. “Why, he nearly killed Greeley! That old man will
suffer for weeks. You mean ten weeks, don’t you?”
“No,” they said. “Ten days is a long time in jail.”
The appellate power came into action.
“Your decision, gentlemen, is overruled.”
Hooker brightened, expecting a remission of at least five days, which

would save his face at the mesa and perhaps prevent the prisoner from
hating him for many years.
“The prisoner will be confined for the period of sixty days, and during that
time he will be employed at hard labor.”
Hooker gasped, trembled, and was speechless.
“You are a man without mercy,” declared old Hostin Nez.
That was my last session of the Indian Court in the [135]Hopi-Navajo

country with native judges sitting. One might as well expect justice from a
goose.
For an Agent who wishes to evade responsibility, the “judges” are an

excellent smoke-screen. He can always say—“It was done by the
prisoner’s own people”: Pilate’s method. Aside from its having all the
elements of farce, it breeds dissatisfaction and ill will among the people,
while teaching them nothing. I know of nothing more unjust, unless it be
the trial of an unlettered Indian according to the strict letter of white man’s
law and the unwavering standard of the white man’s boasted morality.
Thereafter I paid the salaries, and pleasantly chatted with the old
gentlemen when they visited the Agency; but of their legal wisdom I
wanted nothing. The Court proceeded to business without them.
So large an area of country, nearly four thousand square miles, occupied

by two dissimilar tribes and these ancient enemies, should have some
measure of control. The police force I found consisted of three
individuals, two Navajo and one lonesome Hopi. The Agent had found
things so peaceful that he did not need police; which is one way of saying
that he did not bother himself about policing the Empire. And when the
first serious bit of police work became necessary, after five years of
peaceful neglect, the War Department, at the request of the Secretary of
the Interior, detailed one hundred and twenty-five men of the Twelfth
Cavalry as an “escort” to Colonel Hugh L. Scott. This officer of long
experience at Indian diplomacy was sent to review the situation and
conditions. The work completed, he recommended to the Secretary of the
Interior that the Indian Agent should have a force of not less than twenty
men, in charge of a white officer. The [136]Department, therefore, being
unable totally to ignore the opinion of the famous Colonel Scott,
increased my police to eight men, all natives, and left me to whatever
success I could contrive. In 1921 Major-General Hugh L. Scott told me
that he had not changed his opinion.
The Hopi do not make good policemen, and certainly not in a cohort of
one. Their very name implies “the peaceful ones.” Their towns are ruled
largely by pueblo opinion. If a resident acquires the reputation of being
unreasonable and unfeeling, as a policeman often must, his standing in
the outraged community may affect all other phases of his life. Therefore
the Hopi is not likely to become a very zealous officer when operating
alone. And too, the Hopi fear the Navajo, as it is said the Navajo fear the
Ute, and are useless when removed from the neighborhood of their
homes.
But many years ago, when the Hopi were sorely pressed by nomad
enemies and had not even the consolation of telling their woes to an
Indian Agent, they sent emissaries to their cousins, the Pueblo Indians of
what is now New Mexico, and begged for a colony of warriors to reside
with them. In response to this plea, and looking for something to their
advantage, in 1700 came a band of the Tewa from Abiquiu on the Chama
River, from that section where Onate found San Juan de los Caballeros.
To these people the Hopi granted a wide valley west of the First Mesa,
known as the Wepo Wash, providing they would stay and lend their
prowess in future campaigns. They built a village atop the First Mesa,
now called Tewa or Hano, where their descendants live to-day. Some
intermarried with the Hopi, and a few with the near-by Navajo; but they
have not been absorbed, and it is a curious fact that while all the Tewa
speak Hopi and Navajo with more or [137]less fluency, after two centuries
of living side by side few of the Hopi can speak the Tewa dialect.
The Hopi invited warriors, and the warriors have graduated into
policemen, for one learns to police the Hopi districts, and even to
discipline some of the Navajo, with Tewa officers. They are dependable
and courageous, even belligerent; that is to say, they will fight when it is
necessary and, strange thing among desert Indians, with their fists,
taking a delight in blacking the opponent’s eye. But one has to learn that
the Hopi as policemen are fine ceremonial dancers.
The Navajo cohort had been selected following a frontier fallacy. Many of
the old Agents believed that a good police force could be built from the
“bad men” of the community.
“The cattle-thief will know all other cattle-thieves,” was their reasoning.
“The gambler will not be deceived as to those who waste their herds and
silver playing monte. And the meaner an Indian among his own, the more
respect and fear he will stimulate when garbed in a uniform and
authorized to pack a gun.”
As reasonable as if New York officials should make a special deputy of

Gyp the Blood.
Hoske Yega, commonly known as Old Mike, a tall and unscrupulous

Navajo, carried the Chief’s badge. It was said that he had killed more
than one man; and while I am not so sure of this, certainly he was no
example of righteousness. The second officer was not so mean a
specimen, but one of the same system. They had been policemen of the
jurisdiction for many years, believed themselves entitled to the positions,
and knew the game. A Navajo policeman has nothing to learn from the
bulls of the whites as to methods of graft and the blackmailing [138]use of
his badge. The Indian Service has used native police since 1878, and I
will admit that occasionally one finds a jewel of an officer, of good
judgment, trustworthy, brave, and loyal; but for the most part the Indian
policemen of the Desert are go-betweens and grafters.
Providing that the Indian accused of wrongdoing is not of the policeman’s

clan, providing that the policeman is not afraid of him or of his clan,
providing that there is no witchcraft involved, the Navajo policeman can
serve a warrant and get his man as quickly and as unerringly as any
Sherlock Holmes. A skilled tracker, he can read the trail as an open book;
and often he does not need to follow it. Indians leave their visiting cards
behind them. My first knowledge of this came when the corral of Clezzi
Thlani was relieved of several good ponies, and Old Mike was sent forth
to investigate. He recovered most of the stock from the open range, and
reported:
“They were taken by Sageny Litsoi.”
Sageny’s idea had been the common one among Navajo, dating from
wagon-train days: to run the ponies a little further each night until
distance had convinced him that he actually owned the animals. Then a
little tinkering with a hot wire would so confuse brands as to bring even
the records to his support.
“Why didn’t you bring him in?” I asked.
“Didn’t see him—just got the horses.”
“Then how do you know that Sageny is the thief?”
“Went to corral; saw his tracks. Yisconga dahtsi” (to-morrow perhaps) “I

bring in Sageny.”
“You mean the trail will lead to his hogan?”
“No, No! Went to corral; see his tracks—Sageny’s feet. No two Navajo
have feet alike.”
And when Sageny was brought in, although he had many [139]excuses
and claimed that he had raised the animals, he did admit taking animals
having another’s brand; and he occupied the guardhouse for a period as
a guest of the Empire. Several of my Navajo police graduated later into
the same rest-room, which seemed a humorous proceeding to many, and
was not altogether different from the experiences of some white
lieutenants.
It was when I discovered that Tewa could be depended on that better

police-work followed. The point of view was different. One day I
summoned the tall and spare Tewa chief of police, and said to him:—
“Nelson, I want Hostin Chien Bega. You know him?”
“Yes; me know him—call him ‘Bull-Neck.’ ”
“ ‘Bull-Neck’ it is. Can you bring him in?”
“Dahtsi.”
“Well, here are handcuffs. Suppose you try it.”
He took the cuffs and walked away. A short time after he returned, and I
saw that he had buckled on his guns.
“You want ‘Bull-Neck,’ ” he commented. “He mean Navajo—carry two

guns all the time. Sometimes bring in whiskey. Now, how bad you want
him? You want him dead?”
Well, to be plain about it, I did not want Hostin Chien Bega, alias Bull-
Neck, as a morgue exhibit. He was mean enough in the flesh. And I
foresaw the later experience of a brother superintendent who ruled the
reservation on my west line. His domain was if anything a trifle wilder
than mine, reaching to the Grand Cañon and the most remote places of
the Utah border. Its area was a trifle more than five thousand square
miles, inhabited by at least six thousand Navajo, many of whom had
never touched civilization. One Taddytin had graduated from the police
force into a bully of the countryside, and it [140]became necessary to
impose on him a bit of his own medicine. Taddytin was a giant in
physique and quite the meanest man of that territory. Messages
summoning him to the Agency were of no avail. He pleaded illness, that
cover to which retreat all those who do not wish to testify. Taddytin not
only resisted the persons sent to arrest him, but did his level Navajo best
with a .45 gun to get them before they subdued him. The Navajo is quite
handy with a gun at close range. Most of them go armed from the time
they make money enough to purchase a heavy weapon at the nearest
trading-post—a trade permitted by the Indian Office, although in utter
defiance of both Federal and Arizona State law.
The affair came off in a hogan, which is entirely too restricted a place for
serious shooting. Taddytin’s gun twice missed fire, and the persons sent
to arrest him, having been in line with the gun, became nervous and,
strange to relate, lost their judgment. They should have reprimanded
Taddytin for carrying a defective weapon. Instead, they felt it necessary to
shoot Taddytin several times, and although not using one of those fancy
.22’s that O. Henry was wont to ridicule, the first two bullets failed to
knock him down. Unfortunately the last shot killed Taddytin, which was
entirely opposed to all policies of moral suasion.
My brother superintendent, who acts as Indian Agent no longer, defended

himself in the Federal Court, first against a murder charge, and then one
of perjury, from the Spring term of 1916 to and including the Spring term
of 1918. He stood quite alone, save for the testimony of all those who
knew anything about Indians and Taddytin in particular. It cost him quite
four thousand dollars in cash, to say nothing of time and mental
disturbance. [141]The full history of this case may be found in a
Congressional Report (House Doc. 1244) to accompany H.R. Bill No.
5639, dated September 19, 1922—a bill to reimburse the man after his
persecution had ended; a report that is probably forgotten. According to
that report, the superintendent, acting as Indian Agent—
did not receive the support from the Indian Bureau in connection with this
matter to which he was entitled, but instead he was vigorously, and your
committee believes unjustly, prosecuted by the Federal authorities.
You see, the superintendent became the official goat, and suffered that a
glowing policy of big wind and puffery might not be embarrassed.
As this affair occurred to my next-door neighbor, it had a serious effect on
law-and-order conditions within my by no means peaceful jurisdiction, to
the end that I was once reported as murdered and often threatened with
having the report confirmed.
No; I did not urge my Tewa policeman to give a too realistic picture of
loyalty to my commands. [142]
[Contents]
XIII
A DESERT VENDÉE
One noticeable thing about all the Calhoun letters
is the complaint of inadequate support from
Washington.—Abel: Correspondence of James
S. Calhoun
It was a hot sweltering desert day in July when I proceeded

westward from Oraibi to survey for the first time the contentious
pueblo of Hotevilla, Chief Youkeoma’s retreat. I did not expect to
meet this strange personality, but his very name caused me to have
an interest in so rare a character: You-ke-o-ma, or “something quite
nearly complete”—as one might say, “almost perfection.” An
American Dalai Lama.
Several miles beyond the little grotto of the Oraibi war-gods, a

concealed shrine of quaint images, passing that place where
Youkeoma’s adherents lost the contest to decide their traditional
rights in the town of Oraibi, one came to a wall of shattered rock.
These Hotevilla cliffs have little of dignity; they picture chaos, as it
was left by the rending and scarring of some violent earthquake in
the ages gone. To-day the ubiquitous Ford may ascend that wall on
a wide and evenly graded roadway, because I grew tired of risking
my neck there; but it was not so in 1911. My team had a tug of it up a
dipping and winding trail that the Indians, under guard, no doubt, had
crudely torn from the masses of tumbled sandstone.
The second steppe was dotted with thicket from which, on the winds
of springtime, stirs the fragrance of heliotrope. There were patches
of deep sand, and more of rock [143]outcroppings, and then appeared
the fields of the natives, irregular gardens of corn and beans and
melons, growing profusely. These people can make a rock-quarry
bloom and produce food. The Hotevilla are always one year ahead
of famine. At some time in the past they must have suffered
desperately from crop-failure, and that bitter lesson taught them
never again to trust a single harvest.
The pueblo itself was on the westernmost edge of the mesa. There,
where the rocks dropped away again in huge broken steps,
overlooking the vast Dinnebito Wash country, they had built their
curious little houses of stone and mud. If not balanced on the edge
of a precipice, apparently the Hopi are not happy. Fatalists—when
the aged or blind plunge over it is regretted, but not grieved about
sufficiently to disparage the site. Alcoves of the mesa benches were
fenced with cottonwood boughs, and served as hanging balconies
for their burro stock. They had no cattle, few sheep, and fewer
horses; in fact they were and are the poorest of the Hopi people,
having rejected all tenders of acquisition and progress; but in those
things that do not run counter to the traditions, such as cornmeal and
burros, they have great wealth.
There was one man with me, and he advised against going down
into the village. Indeed, I was not inclined to insist on it, for
coincident with our topping the last rise the roofs of the highest
houses had been posted with guards, watching, watching us in an
ominous manner: a custom that prevailed for many years, and one
that causes the stranger to feel a trifle less than comfortable.
“Very likely they feel that we slipped up on them,” I said to my

companion.
“Not at all,” he replied. “They have been expecting you for days.
They knew when you arrived at Oraibi [144]yesterday. Be sure of it,
old Youkeoma has gone underground and will remain in hiding until
the coast is clear. Those watching fellows simply want to know
where you go and when you depart. If we sought to take off a kid or
two to school, there’d be a fine row. They know we have no backing.
I’ll bet they knew when you left the Agency and started out this way.”
All of which proved to be true, and I had later to learn to circumvent

and deceive such mysterious methods of information.
We sat on a baking sand-hill and surveyed the place. It was simply a

dirtier duplicate of the other pueblos I have described, without their
picturesque setting. And if there is a place in America where aroma
reaches its highest magnitude, then that distinction must be granted
Hotevilla on a July afternoon. The sun broils down on the heated
sand and rock ledges, on the fetid houses and the litter and the
garbage, and all that accumulates from unclean people and their
animals. Multitudes of burros and chickens and dogs. Hosts of dogs.
Lank, slinking, half-starved, challenging dogs. Poisonous-looking
dogs that would attack one.
Hotevilla’s sloping streets end at the mesa-edge, and below are the
sacred spring and their sunlit fields. Far away in the northwest, as a
dim blue sail on the horizon, showed Navajo Mountain, that peak of
Indian mystery where the last of their secrets have found refuge. The
Hopi had migrated from that country centuries past, south to the
Little Colorado River; and then, like the back-wash of a wave, had
drifted and settled in his present place of stagnation. Perhaps
Hotevilla had proved his Promised Land.
The smell of cooking arose from the houses, a muttony [145]odor,—

although it may have been burro-haunch,—mingled with smoke and
the thick incense of smouldering cedar. In and out of the doorways
the women passed at their tasks, and one sat weaving a reed
plaque. They were all indifferent, with a contemptuous sullen
indifference, to the stranger. There was a perfect swarm of children,
wary, watching children, ready to dart and hide, long-haired and dirty,
and most of them as nude as Adam.
At one end of the village, and a little apart from it, stood a house with
a peaked roof. This had been the station of the Mennonite Mission,
but when last threatened, the good people departed. It required a
brave spirit to live close to the hostile Hopi. One was likely to reflect
on the fate of Fray Padre José de Espeleta, of the Kingdom of
Navarre, and the difference in theological teaching lent very little
comfort.
Until 1915 the Hotevilla mesa was a very lonely place. The nearest
white neighbors were seven miles away, with rough cañons
between, and no telephone wires; and the nearest authority of the
Government, the Indian Agent, quite fifty miles distant, with no road-
condition assuring speed of rescue in case of trouble. One brave
white woman lived alone on that hilltop until the building of a
Government school brought neighbors. This was Miss Sarah E.
Abbott, a field matron. For many years she had been stationed at the
First Mesa, where she had acquired a knowledge of the Hopi
language. She received orders to confront the Hotevilla, and she did
it. But it was necessary for me to send police several times to arrest
those who sought to intimidate her, and the longest term of
imprisonment ever given old Youkeoma himself, perhaps the longest
ever given an Indian at an Indian Agency, was because of his
threatening this woman. [146]
When it grew near to sunset the men began returning from the fields,
plodding in with their sacks and staves and huge planters’ hoes.
Many of them were aged, their long hair matted and snaky-looking;
but there were enough of the burly, thickset fellows to give any
official pause if he contemplated dictating to that outfit. Even those
who closely observe these people wonder at this evidence of
physique. The Hopi lives largely on a vegetable diet. His teeth are
blunted and worn down like a horse’s from the eating of flint-like
corn. Because of isolation and clan ceremonial exclusion they have
become devitalized through centuries of inbreeding, and quickly
succumb to disease. And yet these same Hopi are famed for two
things requiring raw strength and sustained energy: they can lift and
pack on their backs the heaviest burdens, and they are great long-
distance runners. Many of their ceremonies include the foot race,
notably the sunrise competition on the day of the Snake Dance.
Given a long desert course, fifty to one hundred miles, and the Hopi
runner will wear down a horse. Their ability to bear burdens comes
from both sides of the house, since for ages the women have packed
water from the springs to the heights, and the men the harvests, the
firewood, and the rock for building. I have seen two moving piles of
wood on a mesa-trail, to discover one a burro-load and the other
covering a man, with small difference between them.
And they must have carried weight over distances that compared
with their runs, for how else were the Spanish Missions roofed? The
great timbers were brought on the backs of men. About 1629 the
Hopi, obedient and enslaved, brought these timbers from the San
Francisco Mountains to Oraibi and other points, a feat equaled only
by the Acoma Indians, who built a huge mission atop [147]their penal
height, the beams coming from San Mateo or Mount Taylor. Each of
these packs was more than fifty miles. One of the unused timbers
may be seen to-day in the convento part of the Acoma Mission. It is
a log measuring more than thirty feet in length and two feet in
thickness. Without mechanical equipment, the raising of it to the
mesa-top would tax any man’s ingenuity.
Especially would an official pause in dictation at the time of which I

speak, for the Hopi had defied two former superintendents and for
several years had done exactly as they pleased, in utter disregard of
all admonitions emanating by mail from Washington. Of course
official Washington had not worried, and for the rest of the world the
Hopi do not exist; but the example to about fifteen hundred other and
disciplined Hopi and to several thousand unregulated and
undisciplined Navajo, all in constant touch with these rebels, was not
good. The Agents reaped the effect of this timid policy, and it had
given them concern.
The Hopi had so acted at other times, and the methods adopted to
correct them had not been of the happiest. Officials had threatened
and, when the native did not stir, had offered bribes.
“Your bones will bleach in the sun!” one set had promised—to be
followed by: “Won’t you come in and be good, for a nice new
contract stove?” Now the bleaching process had affected only those
so unfortunate as to die naturally, and the Hotevilla people were
content with their piki stones and adobe fireplaces. The Indian does
not respect those who seek to buy him. When a threat proves as
empty as it is boastful, he is strengthened in no small degree.
Washington has been given to bluffing, and buying. [148]
The Indian Service had not greatly concerned itself about these
strange people until 1887. Between 1847, when the Hopi were
acquired as one of the blessings of the Mexican War, and 1887,
when the first school was planted in Keams Cañon—forty years—
they had lived practically as undisturbed as since their coming from
the cliff- and cavern-dwellings in the northern cañons of the Utah
border. A few traders had visited them often enough to be known;
and one of them, Mr. John Lorenzo Hubbell, has told me of his
witnessing a Snake Dance in the seventies, a solitary white
spectator where now several thousands congregate annually. The
tourist was not in those days, and had he been, under the
circumstances of the back-country, it is likely he would have been
going away from a Snake Dance rather than attending one.
In 1890 the defiance of the Oraibi first caused notice. Old Lo-lo-lo-mi,
their good chief, had been to Washington, and had agreed to place
the children of his faction in the school. His counsels were
disregarded by the opposition; in fact they imprisoned the old man
and threatened him with death for this lapse from the traditions. Lo-
lo-lo-mi was “too good,” as his name implied. The sub-Agent, Mr.
Ralph Collins, arrested several of the war-chiefs and sent them to
their Agent at Fort Defiance. When they returned they busied
themselves making more trouble; so troops were sent to pacify and
coerce them, and the first great blunder was made by an army
officer. This officer accompanied Collins to the Oraibi mesa. They
were warned that the hostiles had armed and meant to fight.
Believing this to be so much bluff, they ascended the mesa to the
pueblo. A war-chief, who had refused to attend a council, stepped
out on one of the terraced houses. He was painted for the occasion,
carried a rifle, [149]and looked the part of his office. He was joined by
a medicine man, who wore a raw sheepskin that dripped blood and
besmeared his body. These two, knowing of many sympathizers
within the hovels, dared the whites to combat and greatly abused
them. The two white men prudently retired after an abortive parley.
Then came five troops of cavalry. The commanding officer invited the
hostile headmen to a council below the mesa, and gave his word
that they should be respected. They came, but stubbornly refused to
change their minds as to this white man’s educational propaganda.
They were then seized and bound as prisoners; and were afterward
marched up the pueblo trail as a screen for the soldiers. This was
rank betrayal, and the effects of it live in the Oraibi country to this
day.
“Some white men do not keep their word.” And at Oraibi, or at least
among unreconstructed Oraibans, who are now at Hotevilla, it is
wisdom to suspect all white men.
Collins, the civilian and sub-Agent, had no part in this. He advised
against it and deplored it. It would have been better to risk a bit of
bad marksmanship, for which the Hopi is noted; it would have been
better to beat a few worthless war-chiefs and medicine men to death,
if that were actually necessary. One can forgive a battle—but
betrayal rankles in the heart.
The prisoners taken at this time were sent to Fort Wingate. In a few
months they were released on promise to be good, but when they
returned from captivity they too refused to keep the parole given.
The goose of an officer had produced a flock of ganders, and his
work was to live for nearly three decades. In 1894 troops were again
in demand at Oraibi, and nineteen of the Indian leaders [150]were
sent as prisoners to Alcatraz Island. They were imprisoned about
eight months, and returned impenitent.
In 1898 the Hopi suffered from smallpox. It was not so bad as that
epidemic told of by the Spanish, but it was severe enough.
Superstition and fright, combined with fatalism, are hard things to
conquer among a people who know nothing of vaccination, who trust
no stranger, but prefer to die unassisted by aliens. Troops were
necessary, to affect quarantine and to cremate bodies. In 1899, say
the records, troops came again, and once more prisoners were sent
to Fort Defiance.
All this time internal dissension was at work among the Oraibans,
and in 1905 differences as to the views of local oracles concerning
the traditions reached a climax. This quarrel involved nearly
everyone within reaching distance. The Commissioner of Indian
Affairs, Francis E. Leupp, the best supporter of discipline the Service
has had in three decades, was at odds with his Agent on this station
and, to tell the truth, this Agent had met one Waterloo at the
Chimopovi pueblo, where an outpost of the Oraibi dwelt. His effort to
coerce the Hopi with an enlarged Navajo police force had nearly
resulted in bloodshed and real war; and at the end of this fiasco the
Navajo mercenaries threatened his life because the pay-chest was
not promptly thrown open to them.
So the Commissioner came to exert a strong personal influence. And

he found speedily that his personal influence in the great Desert
amounted to very little. The Indians had a keen sense of the fitness
of things, and they resented his appearing to negotiate with them
without an official sponsor.
“Who are you?” asked the troubled Oraibi, when invited to a council
with him. [151]
“I am the Commissioner from Washington,” he stated, a fact that was

known to President Roosevelt, the Grid-iron Club, and the New York
Evening Post, and that should have been patent everywhere.
“Why do you come here without Moungwi, then?” they demanded.

“He should introduce you to us. We do not know you. Moungwi is not
here. Why do you come in the back way, from Winslow, and call a
council without Moungwi?”
Indians are often peculiarly consistent. They did not regret that
recent fracas with Moungwi, when they had seized him by the beard
and threatened to toss him bodily from the gigantic Chimopovi cliffs,
—action prevented only by his Navajo police threatening to open fire,
—but they did know something of official courtesy between and
among all Moungwis or Chiefs, and there is such a thing as having
the proper entrée, even with an Indian tribe in the far-removed hills.
Very likely the Commissioner said something about the respect due
his office; when arose a big Indian, who declaimed to this
astonishing effect:—

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Partnership Formation and Operation

C:9-1 Advantages of a partnership for Yvonne and Larry include:

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C:9-7 a, b, and d. p. C:9-12.

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Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

Issue Identification Questions

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The partnership first must characterize each expenditure as an organizational expenditure, a

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C:9-22 • What is George's basis in his partnership interest?

Repayments of partnership liabilities are treated as distributions to the partners. A

Basis at the beginning of the year $15,000

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pp. C:9-21 through C:9-25.

C:9-23 • What is Katie's deductible loss from her partnership investment?

As a limited partner, Katie is presumed not to materially participate in the partnership.

C:9-25 a. Neither partner recognizes gain or loss (Sec. 721).

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Precontribution gain of $1,000 ($15,000 FMV at contribution - $14,000 basis) is allocated to

C:9-26 a. Fred recognizes ordinary income (compensation) of $15,000. Ed recognizes $89,000

c. Al: Cash contribution $ 15,000

Bob: Accounts receivable basis to Bob $ -0-

Clay: Equipment basis to Clay $ 13,000

Dave: Land basis to Dave $ 50,000

Ed: Building basis to Ed $ 15,000

*Or minus $104,000 ($130,000 - $26,000) mortgage assumed

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Dave: Fair market value when contributed $15,000

Other Partners: Postcontribution loss allocated

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Julie Kay Susan

*Or minus $21,600 ($54,000 - $32,400) liabilities assumed by other partners.

Basis Book Value

c. and d. Accounts receivable $ -0- $ 60,000

Kay’s gains are analyzed as follows: Land Building

Cash received $40,000 $ 80,000

pp. C:9-5 through C:9-12, and C:9-19.

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Old partners: (100% x 334/365 x $100,000) + (80% x 31/365 x $100,000) = $98,301

C:9-29 Marjorie: Income: $15,000 ($20,000 FMV of interest - $5,000 cash)

pp. C:9-5 through C:9-12.

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Possible Tax Year-Ends

6/30 9/30 10/31

Partner Partnership Tax Months Months Months

Beta 1/3 6/30 0 .00 9 3.00 8 2.67

C:9-32 Solution appears on next page.

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Separately stated items:

Beginning basis in partnership interest $150,000 $150,000

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(a) (b) (c) (d)

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