Taxation principles

Seminar: Taxation Current Issues
Chapter 21
Respond to Question 1
A partnership agreement is a formal contract detailing all aspects of the partnership, including the share of gains, losses, capital and contingency. It is a precaution to protect the interests of of member of the relationship.
The partnership agreement should include the name of the party, including the contact information, the length of the relationship, the intent and form of the partnership, the contributions of each partner, the power of authorisation, the withdrawal agreement, the percentage of gains and losses, the personal use of the partnership resources and all kinds of contingencies.
Respond to Question 3
In the form of 1065 and 10K, the partnership shall report its revenue. However, there is a relationship not a taxable entity. Most of the elections are made by the partners related to the partnership income and deductions. Several theories are related to the treatment, including:
The entity theory: it treats partnership as a distinct entity.
The aggregate theory or the conduit theory: It simply is based on the conception that the income flows through the partners.
Under the treatment of the entity theory, the partnership documents a return in which most of the elections regarding the treatment of the items of partnership are made. On the other hand, in case of the aggregate theory, in conjunction with the return, partnership does not calculate or pay any tax.
Answer to question number 5:
Depreciation of property in case of partnership will be done in the same way to that of the partner depreciate it. The carryover basis – partner’s cost will be used rather than the FMV. MACRS will be used for additional calculation. A new basis will be used to treat it and depreciation will be commenced at the same date when the costs actually incurred.
Answer to question number 8:
Guaranteed payments are independent of profit or loss and are always made to partners. To ensure each partner is compensated for their contributions, in terms of good and services, guaranteed payments ensue. Without guaranteed payments, it will be hard for partners to keep them motivated or to earn their livelihood considering the time and effort the invest in the business.
Guaranteed payment is debited in the 10th line of the 1065 form as an expense to business. The K and K-1 schedules of the partnership return also has the listing of the payment. In the form 1040 (Schedule E) individual partner reports the item as an ordinary income, along with his distributive share of the partner’s other ordinary income.
Answer to question number 15:
In a proportionate non-liquidating distribution of cash from a partnership, a partner only recognizes gain if the received cash exceeds his outside basis. A partner will recognize only under limited conditions and with the termination of his interest in the partnership. In this regard it is similar to the one from a Subchapter C corporation to a shareholder

Answer to question number 16:
The gross income of Enrico from the ordinary income of ABC during the tax year will be, 40% of 80,000 = $32,000
The gross income of Enrico from the LLC’s Distribution will be, 40% of 10,000 = $4,000.
Answer to question number 18:
Adjusted Basis Fair Market Value Income Recognized Character
From Fenton
Cash $50,000 $50,000
Accounts Receivable – $90,000 $90,000 Ordinary Income
Inventory $25,000 $60,000 $35,000 Ordinary Income
From Myers
Cash $200,000 $200,000
Note: Under general sense the character of gain or loss is recognized based on the use of assets. However, to prevent the conversion of ordinary income into capital gain, a partnership gain or loss is treated as ordinary when partnership disposes of either of the following:
– Receivables for the delivery of the services,
– All tangible property except capital assets and real or depreciable business property,
– Partnership basis would be carryover basis form contributing partner.
Answer to question number 19:
a. The partnership acquired ($6,000×12) = $72,000 for the year as the guaranteed payments, which will be subtracted from the partnership.
b. After the deduction for guaranteed payments, the ordinary income will become = $92,000–$72,000 = $20,000.
c. Stella will have an ordinary income that amount to $72,000. One the other hand, Euclid has a nontaxable distribution of $10,000.
Answer to question number 20:
a. Land recorded for 704 (b) section of book capital account purposes at Fair Market Value of $200,000. Padgett records the land at $200,000.
b. Padgett’s tax basis in the land is $50,000.
c. Nova’s basis = $50,000
Oscar’s gain = ($300,000 –$200,000) × 50%
= $50,000
Nova reports = $0
Answer to question number 21:
The basis of Elisha’s can be computed as: cash, 200,000 + P/S liability for land, 70,000 + liability, 10,000 + liability, 4,100 + NI, $15,000 = $299,100.
The basis of Ezra can be computed as: 340,000 land, (140,000) liability taken over by P/S, + 70,000 P/S liability + 10,000 liability, + 4,100 liability + 15,000 NI = $299,100.
Answer to question number 23:
Particulars Amount ($)
Adjusted Basis 273,200
Less: Cash Received 191,240
Realized Loss 81,960
The partnership later sell the land to a third party for $300,520. The partnership has a realized gain of $109,280 and a recognized gain of $27,320 on its land sale.
Particulars Amount ($)
Cash Received 300,520
Less: Adjusted Basis of partnership 191,240
Realized Loss 109,280

Particulars Amount ($)
Cash Received 300,520
Less: Adjusted Basis of Heather 273,200
Realized gain 27,320
Answer to question number 25:
Statement of gain or loss
Particulars Amount ($) Calculation
LLC Interest 150,000
Cash distributed to the partners 55,000
Remaining balance LLC interest 95,000 150,000-55,000
Partnership inside the basis of inventory distributed 45,000
Bruno basis in the other property distributed 50,000 95,000-45,000
Basis in the land 50,000
Net gain or loss 0 50,000–50,000
Note: Bruno basis in the inventory is $45,000 and his basis in the land is $50,000
Answer to question number 28:
a.

a. Shawna would not recognize any gain and loss since the partners contribute property to the partnership, under section 721.
b. Kenisha’s basis in the LLC would be $360,000.
c. Shawna would have basis of $380,000 in her LLC interest.
d. $380,000 of a property contribution is taken as the basis of Shawna in the property of LLC.
Answer to question number 32:
a. Sam will recognize n gain. According to the section 721, neither of the members of LLC or the LLC itself can recognize any gain from the property contribution to an LLC for the exchange of LLC interest.
b. The basis of Sam for taking interest will be $100,000.
c. As an ordinary income, Drew will recognize an amount of $50,000.
d. A $200,000 basis will be used by Drew in taking her interest from the LLC.
Answer to question number 35:
a. Initial Basis: J = $420,000 and M = $720,000.
b. Selling Price = $620,000
Basis = $420,000
Gain/ Loss = $200,000
Land being the inventory of the partnership, the gain is an ordinary income. Although it was a capital asset for Jessica, there is not option for her to treat it as a capital because of her use.
c. Selling Price = $580,000
Basis = $720,000
Gain/ Loss = ($140,000)
The loss can be seen as composed of $20,000 ordinary loss and $120,000 of capital loss. The sale takes place within 5 years of time from the capital contribution of the asset, which makes the loss as capital up to the extent of built-in loss at the contribution date, which is equal to the $120,000, whereas the rest is ordinary loss.
d. If the property sold after 5 years of capital contribution then total will be considered as an ordinary loss. Therefore, in case of such a sale in 2023, we can consider the total loss of $140,000 as an ordinary loss, which is because the loss will be counted on the sale of inventory of partnership asset.
Answer to question number 40:
The result from the excel sheet is as follows:

c. $30,000 gross. As per rule, all unrealized gain or loss at the date of contribution of the property for an LLC interest belongs to the contributing partner only. So, the loss of $30,000 will be entirely allocated to Reece.
d. Here is the balance sheet:
Particulars Basis FMV Particulars Basis FMV
Cash $90,000 $90,000 Interest Phoebe $15,000 $90,000
Land $30,000 $180,000 Interest Parker $15,000 $90,000
Interest, Reece $90,000 $90,000
Total $120,000 $270,000 $120,000 $270,000

Answer to question number 41:
a. As per section 704 (C), the land sale the unrealized gain or loss is computed as below:
Loss on sale = $120,000 (FMV) –$84,000 (Selling Price) = $36,000
Reece’s basis being $120,000, his allocation as per section 704 will be the basis on the contribution date deduct the land’s FMV of $90,000 on the same date = $120,000 –$90,000 = $30,000.
The remaining loss of ($36,000 –$30,000) = $6,000 will be allocated equally with an amount $2,000 each to Phoebe, Parker, and Reece.
b. Here is the required balance sheet:
Particulars Total Phoebe Parker Reece
Balance Before sales $150,000 $15,000 $15,000 $120,000
Less: Built-in sale $30,000 $30,000
Less: Loss on land after contribution date $6,000 $2,000 $2,000 $2,000
Balance after sales $114,000 $13,000 $13,000 $88,000