This examination consists of three essay questions, each of which will be given equal weight in determining grades. Two and a half hours (150 minutes) will be permitted for this examination. At the end of the two and a half hours, your answers to these essay questions will be collected. This set of questions will not be collected, and no credit will be given for anything written on it.

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 50 minutes. 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 that all partners and partnerships described in the questions report their income on the calendar year and on the cash method for federal income tax purposes.
 
 

On June 1, 1989, Andrea, Bert and Chris form a general partnership, the ABC partnership, to develop and sell real estate. At the time of its formation, the profits of the partnership are difficult to predict with any degree of confidence.

The partnership formation consists of the following:

Andrea transfers to the partnership undeveloped real estate with a fair market value of $100,000 and an adjusted basis of $20,000. The property is encumbered by a mortgage of $30,000; Andrea's "equity" before the exchange was therefore $70,000. The partnership assumes the mortgage. Andrea's share of the partnership's profits is one-third.

Bert transfers to the partnership his agreement to perform services over the next five years developing the real estate and selling it to ABC's customers. Bert receives no capital interest for this agreement, but he does receive a one-third interest in partnership profits, if there ever are any.

Chris transfers to the partnership an account receivable from a former business of hers. The receivable has an adjusted basis of zero and a face amount and fair market value of $70,000. Chris's share of partnership profits is also one-third. On December 1, 1989, the partnership collects the $70,000 from the receivable.

Answer each of the following questions:

A. What are the federal income tax consequences to Andrea, Bert, Chris and ABC of the transfers in connection with the formation of the partnership? Be sure to discuss the amount and timing of any gain, income, loss or deduction to each party, and each party's basis in the partnership interest or other property that party receives.

B. What are the partners' capital accounts immediately after the partnership is formed?

C. What are the federal income tax consequences to Andrea, Bert, Chris and ABC of the collection by the partnership of the receivable? Be sure to discuss the amount and timing of the income, if any, to each party, and the effects on the partners' basis in their partnership interests.

Discuss.

Dexter, Edith and Fiona are equal partners in a general partnership, the DEF partnership. On August 1, 1989, the partnership's assets are as follows:

Asset.........................Basis.............Fair market value

Cash..........................$510,000............$510,000

Inventory....................$ 60,000.............$ 90,000

Stock (capital assets)..$210,000............$300,000

Total..........................$780,000.............$900,000

The partnership has no liabilities, and so the partners' equity is as follows:

Partner............Basis............Fair market value

Dexter...........$260,000............$300,000

Edith.............$260,000............$300,000

Fiona............$260,000.............$300,000

Total.............$780,000............$900,000
 

Dexter, tired of participating in the partnership, decides to retire. The three partners agree that Dexter's interest will be disposed of in one of two ways:

A. Dexter sells half his interest to Edith for $150,000 cash, and the other half of his interest to Fiona for $150,000 cash.

B. The partnership distributes the stock to Dexter in complete liquidation of his interest.

What are the federal income tax consequences to Dexter, Edith, Fiona and the partnership of each of these two proposals? Be sure to discuss the amount, timing and character of any gain, income, loss or deduction to each party; and, immediately after the transactions, the basis of Edith's and Fiona's partnership interests, the partnership's basis in its property, and (under transaction B) Dexter's basis in the stock.

Explain.

Jan and Kurt form a partnership, the JK partnership. Each contributes $50,000 cash. On January 1, 1989, the partnership borrows $900,000 on a recourse basis from a bank, and buys a building for $1,000,000 cash. The building is immediately placed in service in the partnership's business. Assume for purposes of this question that the proper ACRS deduction for the building is $35,000 a year.

For the first two years of its existence, the partnership's operating income (without taking into account the ACRS deduction on the building) is exactly zero, in that its receipts and expenses match exactly. The partnership agreement allocates all of the partnership's ACRS deductions to Jan; all other items of income, loss, deduction and credit are allocated equally between Jan and Kurt. In accordance with these allocations, Jan takes a $35,000 loss deduction, passed through from the partnership, on her federal income tax return for each of the years 1989 and 1990.

Jan and Kurt come to you in 1991 and ask you to determine whether the $35,000 deductions Jan took for 1989 and 1990 were proper. They offer to show you the partnership agreement.

Write a memo explaining how one determines whether deductions such as Jan's were proper. Are provisions of the partnership agreement relevant to this inquiry? If so, which provisions are significant for tax purposes? Is it possible that some part of Jan's deductions may have been proper while another part was not? How?

Discuss.