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3: income items and contributions first increase basis, then basis is reduced by distributions from the partnership. Finally, losses may be deducted under § 704(d) to the extent of any remaining basis. However, this allowed loss may be further limited under the at-risk and passive loss rules. In Brad‟s case, the $20,000 distribution reduces his basis in the partnership interest to $0 and Brad must recognize a $5,000 gain (probably a capital gain) in the amount of the distribution that exceeds his $15,000 basis. Since his basis is reduced to $0, none of the loss can be deducted. The full $10,000 is suspended under § 704(d) and must be carried forward until Brad has adequate basis to absorb the loss. If the partnership can make the distribution at the beginning of the following tax year, Brad could deduct the loss in the current year. The partnership expects to report earnings in future years, so Brad‟s share of that income would increase his basis before the cash is distributed, and he will probably not be required to report a capital gain on the distribution. Alternatively, the partnership could incur additional (short-term) debt at the end of the year. This approach would be treated as a contribution of capital that increases Brad‟s basis in his partnership interest. With adequate basis, the cash could be distributed without gain recognition, and the losses would be fully deductible. Figure 10.3 and Examples 28, 29, 37, and 38
a. b. c. d.
Under § 721, neither the partnership nor the partners recognizes any gain on formation of the entity. Chip will take a cash basis of $200,000 in his partnership interest. Marty will take a substituted basis of $100,000 in his partnership interest ($100,000 basis in the property contributed to the entity). The partnership will take a carryover basis in the assets it receives ($200,000 basis in cash, and $100,000 basis in property).
Example 14 16. a. Carol realizes a gain of $20,000 on contribution of the land. Connie realizes a gain of $60,000 on contribution of the equipment. The partnership realizes a gain equal to the value of the property it receives (it has a $0 basis in the partnership interests it issues). Under § 721, neither the partnership nor either of the partners recognizes any gain on formation of the entity. Example 8 Carol will take a substituted basis of $70,000 in her partnership interest ($30,000 cash plus $40,000 basis in land). Connie will take a substituted basis of $30,000 in her partnership interest ($30,000 basis in the equipment). Example 14
10-14 The partnership will „„step into Connie‟s shoes” in determining its depreciation expense. The partnership will take a carryover basis in all the assets it receives ($30.000 $160. the calculation is as follows: Capital account balance.000 basis in equipment).000 land plus $30. p.000 40. 10-12 The partners‟ outside bases in their partnership interests total $100. This is the same as the partnership‟s basis in assets of $100. It will use the remaining depreciable life and the same depreciation rates Connie would have used. 27.000 plus Connie‟s basis of $30.d. and $30.000 basis in land. .000 equipment). p.000 basis in cash. e.000 ($30.000.000 f. a. 10-12 Assuming that Erica‟s capital account reflects an accurate number for basis purposes.000 cash plus $40. $40.000: Carol‟s basis of $70.000 × 1/2) Erica‟s basis. beginning of year Share of EG‟s debt ($80. beginning of year $120. p.
beginning of year Add: Taxable income Tax-exempt interest income § 1231 gain Long-term capital gain Less: Short-term capital loss Political contribution Charitable contribution Payment of Erica‟s medical expenses Cash distribution to Erica Plus: Share of EG‟s debt ($100. To determine the required tax year of an LLC (partnership) under this method. The same taxable year as all of the principal (5% or greater interest) partners.000 10.000 2.3 Research Problem 3 a.000 500 $ 1.500 Note that payment of Erica‟s medical costs is treated as a distribution to Erica. Multiply the number of income deferral months for each partner by each partner's profit percent. Either June 30 or December 31 would be an acceptable year-end. Therefore.000 $226. Also note that the political contribution decreases her basis even though Erica cannot deduct the expense. the principal partner rule does not apply. end of year $70. Select one partner's tax year as a test year. CT.500 (17. the LLC (partnership) required taxable year is the first of the following that apply.b. Under § 706(b)(1). but since both members do not have the same taxable year. majority interest taxable year. Capital account balance.000 $120.. and Figure 10. LLC must choose the taxable year that provides for the least aggregate deferral of income. The year determined under the “least aggregate deferral” rules. as explained in the The regulations.500 $193.000 73. The majority interest taxable year does not apply since neither of the LLC members has a majority interest (>50%) in the profits and capital of the LLC. Examples 34 and 35. (§ 704(b)(4)(A)) Both Cameron and Totco are principal partners (5% or greater interests) in the CT.000) $176.500 500 1.000 × 1/2) Erica‟s basis.000 4.500 50. Add the products to determine the aggregate number of deferral months for the . LLC.e.000 1. determine the number of deferral months for each partner). Calculate the number of months from the end of the test year to the next yearend for each partner (i. perform the following steps.
if this calculation results in two taxable years with the same least aggregate deferral. the December 31 partnership taxable year could be retained only if the LLC could get approval from the IRS for a “natural business year” or by making a § 444 election. copied or duplicated. if Totco. The problem states that CT does not have a natural business year. All Rights Reserved.706-1(b)(3)(i)). Proc. a partnership has automatic approval from the IRS to make this change. Under Reg.00 Aggregate number of deferral months 3.706-1(b)(9).'s year-end) Months of Partner Year Ends Profit Interest Deferral Product Cameron 12/31 1/2 × 6 = 3. If the partnership originally selected a December 31 taxable year. in whole or in part. The majority interest rule will now apply and Totco.00 Totco.test year.706-1(b)(8)(i)(A). 6/30 1/2 × 6 = 3. 6/30 1/2 × 0 = 0. Inc. the year end of the LLC will remain June 30. Under regulations. § 1. § 1. § 1. TEST FOR 6/30 YEAR-END (Totco.706-1(b)(8)(i)(C)). sells a portion of its interest to a calendar-year individual). the LLC will not be required to change its year again within two years after the initial change (Reg.g.. 2006-46 (2006-45 IRB 859.00 Under the least aggregate deferral test. the taxable year of the LLC must change to June 30. Compare the aggregate number of deferral months for each test year. May not be scanned. Under Reg. § 1. TEST FOR 12/31 YEAR-END (Cameron's year-end) Months of Partner Year Ends Profit Interest Deferral Product Cameron 12/31 1/2 × 0 = 0. A § 444 election is not available since the 6-month deferral from the required taxable year is greater than the maximum 3-month deferral permitted under § 444.00 10-48 2010 Annual Edition/Instructor’s Guide with Lecture Notes © 2010 Cengage Learning. b. the partnership may select either one of these taxable years as its taxable year..00 Aggregate number of deferral months 3. . If the partnership originally selected a June 30 taxable year. Inc. Inc. The change from a December 31 taxable year to a June 30 taxable year will be made under the provisions of Rev. Repeat the process until each partner's tax year has been used as a test year. [§ 444(b)(2)]. 10/18/06). a June 30 fiscal year taxpayer will own a majority (75%) interest in the LLC.00 Totco. both a June 30 and December 31 year end provide for the same amount of deferral. Inc. If the year end changes again under the majority interest rule (e. (Reg. Inc. or posted to a publicly accessible website. test year that has the smallest number of aggregate deferral months is the The required tax year.