Partnership Taxation

Spring 2016

Bogdanski

 

FINAL EXAMINATION

(Three hours)

 

INSTRUCTIONS

 

            This examination consists of three essay questions, each of which will be given equal weight in determining grades. Three hours will be permitted for this examination.

 

            At the end of the three hours, you must turn in this set of essay questions in the original envelope in which this set came. If you wish to submit handwritten partnership balance sheets with your answers, you must (1) enclose them in the envelope, clearly labeled with your exam number and the question to which they relate, and (2) refer to them in your answers.

 

            If you are using a computer, unless you have been otherwise expressly authorized by the law school, you must submit your answers using SofTest. If you are writing answers by hand, you must write them all in the bluebook(s) you have been provided, and return the bluebook(s) along with this set of questions in the envelope.

 

            No credit will be given for anything written on this set of questions. Only your electronic answer file or bluebook(s), and any enclosed balance sheets, will be graded.

 

            Pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit. Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.

 

            The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.

 

            Unless otherwise instructed, you should assume that:

 

○          all partners described in the questions are individuals and U.S. residents;

 

○          all partners and partnerships described in the questions use the calendar year as their taxable year for federal income tax purposes; and

 

○          all partners and partnerships report their income on the cash method for such purposes.

 

Any references to “the Code” are to the Internal Revenue Code of 1986, as amended.

 

 

 

QUESTION ONE

(One hour)

 

            Alma and Boris form a limited liability company, ABL. In the formation transaction, Alma transfers to ABL stock in Hugeco, a corporation. Immediately before the transfer, the Hugeco stock has an adjusted basis in Alma’s hands of $400,000, and a fair market value of $500,000. In the same formation transaction, Boris makes a transfer to ABL of Blackacre, a commercial building on leased land. Immediately before the transfer, Blackacre has an adjusted basis in Boris’s hands of $200,000 and a fair market value of $500,000.

 

            In exchange for the assets they contribute, Alma and Boris each receive a one-half interest in ABL’s profits and losses. The operating agreement of ABL satisfies the primary test for economic effect under the regulations under section 704(b) of the Code.

 

            In ABL’s hands, Blackacre is subject to depreciation. Taking into account the period during which Boris has been taking depreciation deductions, the remaining cost recovery (depreciation) period for Blackacre is 10 years. Assume that if ABL purchased Blackacre from a third party, the recovery (depreciation) period for Blackacre would be 20 years. Assume also that Blackacre is depreciated on the straight-line method, with no applicable conventions.

 

            In the first year of ABL’s operations, all of its gross income and deductions just happen to offset each other exactly – except for the depreciation deduction with respect to Blackacre. This deduction generates an operating loss for ABL for tax purposes of $20,000 for the year. ABL continues to hold the Hugeco stock.

 

            Assuming that ABL does not choose to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Alma, Boris, and ABL – with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party’s basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.

 

            Discuss.

 

(End of Question 1)

 

 

 

QUESTION TWO

(One hour)

 

            Xander and Yvette are partners in a general partnership, XY. XY, which has not elected to be taxed as an association, is engaged in a professional practice. The partnership agreement of XY, which meets the primary test for economic effect under the regulations under section 704(b) of the Code, states that all income and loss of the partnership is to be allocated equally between Xander and Yvette.

 

            At the end of the year, having taken into account all of the transactions entered into by the partnership during the year but before the distributions described next, the balance sheet of XY is as follows:

 

Assets

Liabilities

 

 

Basis

Fair market value

 

Basis

Fair market value

Account receivable

-0-

$ 100,000

Debt

 

-0-

Land held by XY for investment

$ 180,000

100,000

 

 

 

 

 

 

Partners’ equity

 

 

 

 

 

Xander

$ 90,000

$ 100,000

 

 

 

Yvette

90,000

100,000

Total assets

$ 180,000

$ 200,000

Total liabilities

$ 180,000

$ 200,000

 

 

Neither asset was contributed to XY by a partner.

           

            On the last day of the year, Xander and Yvette break up the firm. XY liquidates, distributing the capital asset to Xander and the account receivable to Yvette. A few months later, Yvette collects $100,000 cash on the receivable. Four years later, Xander, who becomes a real estate professional, subdivides the land and sells lots to customers at a substantial profit.

 

            What are the federal income tax consequences of the transactions just described – to Xander, Yvette, and XY – with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party’s basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.

 

            Explain.

 

(End of Question 2)

 

 

 

QUESTION THREE

(One hour)

 

            Corp, Gabriela, and Hannah form a limited partnership, CGH. Corp, a corporation, is the sole general partner; Gabriela and Hannah are the limited partners. In the formation transaction, Corp transfers to CGH $10,000 cash.

 

            In the same transaction, Gabriela transfers to CGH Redacre, a parcel of undeveloped real estate that Gabriela has been holding for investment. Immediately before the transaction, Redacre has an adjusted basis in Gabriela’s hands of $500,000; Redacre’s fair market value at the time is $1,000,000, but it is encumbered by a recourse mortgage securing a business loan with an outstanding principal balance of $800,000, so that Gabriela’s “equity” in Redacre is $200,000. Gabriela obtained the loan from a bank several years ago, using Redacre as collateral. CGH assumes the mortgage on Redacre – that is, CGH promises Gabriela that CGH will pay off the loan, and it will make Gabriela whole if Gabriela is ever required by the lender to satisfy any of the debt. The mortgage requires payment of interest only for several years.

 

            Also in the formation transaction, Hannah transfers to CGH equipment with a fair market value of $600,000 and an adjusted basis in Hannah’s hands immediately before the transaction of $100,000. The equipment is owned free and clear of any mortgages.

 

            The partnership agreement of CGH provides that profits and losses are initially to be shared 20 percent by Corp, 20 percent by Gabriela, and 60 percent by Hannah. Under the agreement, this allocation will prevail until such time as CGH has achieved an aggregate positive net cash flow, which is not expected to be the case for several years. Once that milestone is achieved, profits and losses are to be shared 40 percent by Corp, 10 percent by Gabriela, and 50 percent by Hannah.

 

            The partnership agreement provides that capital accounts are to be maintained in accordance with the regulations under Section 704(b) of the Code. Accordingly, each partner receives a credit to the partner’s capital account equal to the amount of cash or fair market value of property contributed to CGH, minus (in Gabriela’s case) the liability to which the contribution was subject. The agreement also provides that upon any liquidation of a partner’s interest, the partner shall receive a distribution equal to his or her positive capital account. Corp agrees to pay in cash to CGH any negative capital account that Corp might have when its interest is liquidated; Gabriela and Hannah do not accept such a provision as to them, but they do agree to a “qualified income offset,” as described in the regulations.

 

            In the first year of its operations, for federal income tax purposes, CGH has gross income of $800,000 and deductions of $900,000, for a net operating loss of $100,000.

 

            Assuming that CGH does not elect to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Corp, Gabriela, Hannah, and CGH – with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party’s basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.

 

            Discuss.

 

(End of examination)

 

 

 

Created by: bojack@lclark.edu
Update:  20 May 16
Expires:  31 Aug 17