corporate & partner tax instructor: dwight drake contributed property – 704(c) general rule:...

Corporate & Partner Tax Instructor: Dwight Drake

Contributed Property – 704(c)

General Rule: Built-in gain or loss allocated to the contributing partner.

But what if actual gain or loss less than built-in gain of loss?

Traditional Approach: Ceiling Rule kicks in. Max allocated to contributing partner is actually tax gain or loss. Book tax disparity perpetuated.

Traditional Approach with Curative Allocation: Can allocate extra amount of other gain or loss of same character to eliminate book and tax disparity.

Remedial Approach: Allocate to noncontributing partner tax gain or loss equal to book gain or loss, and then have remedial allocation to contributing partner to offset any extra gain or loss allocated to noncontributing partner.


Law T510 - Estate and Gift Tax-Instructor: Dwight Drake

Problems P. 196 – 1

a) Partnership sells ARs for 10k. 10k ordinary income allocated to A per 724 and 751(c). No book gain because book capital account at FMV going in.

b) Partnership sells lots from B for 10.6k. Lots 751(d) inventory because B dealer. All income recognized within 5 yrs of contribution ordinary. First 5k built-in gain to B, next 600 allocated equally to partners. Each partner’s capital account up 200.

GenPartnership

A B C AR 10k (basis 0) lots 10k (basis 5k) land 10k (basis 20k)

Real estate dealer Investor

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(c) B’s lots sold for 9100. 4100 gain (9100 less 5k basis) allocated to B under ceiling rule. Each partner’s capital account reduced 300k to recognize loss from FMV, but has no other tax effect.

(d) Same as (c) but partnership elects remedial allocation method. Ceiling distortion eliminated. A and C each get 300 loss, with corresponding income item to B. B thus has 4700 income (4100 plus 600).

GenPartnership



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(e) Partnership, as real estate dealer, sells land for 17k. Capital loss of 3k because capital asset in C’s hands and sold within 5 years. 3k LTCL allocated to C under ceiling rule. For book purposes, each partner has 2,333 gain (1/3 of 7k). Disparity from ceiling rule can be avoided by traditional method of curative elections under Reg. 1-704-3(c) or remedial method under Reg. 1-704 – 3(d).

GenPartnership



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(f) Same as (e) except land sale for 7k. First 10k capital loss allocated to C. Next 3k loss allocated 1k each to other partners, and is ordinary loss because partnership is dealer. This 3k exceeds all precontribution loss. Each partners capital account reduced 1k.

(g) What effect if sales occurred six years after property contributed? 724 inventory taint and capital loss taint disappear after 5 years. Gains and losses lots in (b) and (c) capital because partnership not dealer. Gains and losses in (e) and (f) ordinary because partnership is dealer.

GenPartnership



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(a) Bldg 10 yr, STL. Under traditional method, how much book and tax depreciation? 5k tax depreciation (10% of basis) and 10k book depreciation (10% of FMV – capital account value). Book depreciation allocated equally – 5k to each partner. Per 1.704-3(b), tax depreciation allocated to non-contributing partner (A) to extent of book depreciation. Hence, 5k tax depreciation all allocated to A.

(b) Base in building 60k. What effect? Tax depreciation 6k (10% of 60k). 5k tax depreciation to A (noncontributing partner) and 1k excess allocated to B.

ABPartnership

A B 100k cash Bldg (FMV 100k; 50k basis)

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(c) Basis is 40k? What impact? 4k tax depreciation (10% of 40k). Book depreciation the same. All 4k tax depreciation allocated to A.

(d) Building basis 120k? What impact? 12k tax depreciation; 10k book depreciation. A allocated tax depreciation equal to A’s book depreciation (5k). Excess 7k depreciation allocated to B, contributing partner.

(e) In (a) building held for two years, then sold for 90k. Basis after two yrs is 40k (50k-10k). Gain is 50k (90k-40k). Book gain is 10k (90k – 80k). Tax gain allocated equally to A & B to extent of book gain. Balance to B under 704(c). Hence, 5k gain to A, 45k gain to B.

ABPartnership


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(f) Same as (e), but building sold for 60k. Tax gain is 20k (60-40). Book loss of 20k (60k-80k). Per 704(c), B must recognize gain up to the remaining built-in gain (excess of 80k FMV over 40k basis). Ceiling rule would limit B’s gain to 20k.

(g) Basis 40k, 20 yr life, partnership elects remedial approach. What depreciation? Tax depreciation yrs 1-10 is 4k (40/10). Book depreciation yrs 1-10 is 7k (40/10 + 60/20) and 3k yrs 11-20 (60/20). For yrs 1-10, 3.5k tax allocated to A, each to A’s share of book, and .5 k remaining tax allocated to B. For yrs 11-20, there is no tax depreciation. Under remedial approach, A allocated 1.5 depreciation (equal to book), and B allocated 1.5 income.

ABPartnership


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Problem 196 - 3 Buy land as joint tenants and contribute to partnership or buy

through partnership? Both partners are dealers.

(a) If they buy and contribute, their dealer status will taint property as inventory for 5 yrs. If partnership buys, 724(b) not apply and property may qualify as investment property from day one.

(b) Buy land for 100k. Appreciate to 200k by year three. C contributes 100k cash for 1/3 interest, which used to improve property. Sell for 450k. How allocate gain 250 gain (450 – 200 basis). 100k allocated to A & B, built-in gain at C admission. Excess 150k allocated equally – 50k to each.


Problem 196 - 3 Buy land as joint tenants and contribute to partnership or buy

through partnership? Both partners are dealers.

(c) What result in (b) if use reverse 704(c) election and apply traditional allocation method? Restate book accounts on C’s admission to FMV – 200k. Thus, book gain on sale is 150k (450k – 300K) and tax gain of 250 (450 – 200). Book gain allocated equally to all three – 50k each. Excess tax gain of 100k allocated to A & B. Same net result as in (b).


Problem 196 - 3 Buy land as joint tenants and contribute to partnership or buy through

partnership? Both partners are dealers.

(d) What result if no adjustment to capital accounts when C admitted and no special allocation of built-in gain? Here, 250 gain allocated equally to each partner – 83,333 to each. Capital accounts as follows:

No allocation Allocation

A 133,333 (50 + 83333) 150,000 (50 + 100)

B 133,333 (50 + 83333) 150,000 (50 + 100)

C 183,333 (100 + 83,333) 150,000 (100 + 50)

Total 450,000 450,000

Result: Economic value shift of 33,333 from A & B to C. Could be treated as gift if relatives or compensation payment if employee.


Problem 196 - 3 Problem 185-1 Capital Accounts Recap

Partnership Partnership Partnership PartnershipA Basis A Capital B Basis B Capital C Basis C Capital Assets Basis Assets Book Capital Basis Capital Book

Initial Contributions 0.00 10.00 5.00 10.00 20.00 10.00 25.00 30.00 25.00 30.00

Traditional ApproachSell Acc Rec for 10k 10.00 10.00 5.00 10.00 20.00 10.00 35.00 30.00 35.00 30.00Sell B Lots for 10.6k 10.20 10.20 10.20 10.20 20.20 10.20 40.60 30.60 40.60 30.60Sell B Lots for 9.1k 10.00 9.70 9.10 9.70 20.00 9.70 39.10 29.10 39.10 29.10Sell C Land for 17k (Assume 9.1k for lots) 10.00 12.03 9.10 12.03 17.00 12.30 36.10 36.10 36.10 36.10Sell C Land for 7k (Assume 9.1k for lots) 9.00 8.70 8.10 8.70 9.00 8.70 26.10 26.10 26.10 26.10

Curative/Remedial ApproachSell Acc Rec for 10k 10.00 10.00 5.00 10.00 20.00 10.00 35.00 30.00 35.00 30.00Sell B Lots for 10.6k 10.20 10.20 10.20 10.20 20.20 10.20 40.60 30.60 40.60 30.60Sell B Lots for 9.1k 9.70 9.70 9.70 9.70 19.70 9.70 39.10 29.10 39.10 29.10Sell C Land for 17k (Assume 9.1k for lots) 12.03 12.03 12.03 12.03 12.03 12.30 36.10 36.10 36.10 36.10Sell C Land for 7k (Assume 9.1k for lots) 8.70 8.70 8.70 8.70 8.70 8.70 26.10 26.10 26.10 26.10

corporate & partner tax instructor: dwight drake contributed property – 704(c) general rule:...

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