Entering

1
Entering ExitingPartnerships LLCsThe Real
Cost!

• 2009
• American Society of Women Accountants
• Northwest Regional Conference
• May 14-16, 2009
• Presented by Wendy Wixson

2
Overview

• Contribution to partnership
• General rule and exceptions
• Distribution to partner
• General rule and exceptions
• Disposition of partnership interest
• Sale and exchange
• Abandonment

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Contributions

• General rule
• 721(a) - Nonrecognition of gain or loss on
  contribution
• No gain or loss shall be recognized to a
  partnership or to any of its partners on a
  contribution of property to the partnership in
  exchange for an interest in the partnership

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Contribution Exceptions

• 721(b) - Investment partnerships
• If appreciated stock or securities are
  contributed to a partnership that would be
  treated as an investment company (if it was a
  corporation), gain is recognized
• The same rule does not apply to losses
• If 80 of the value of the assets are held for
  investment and those assets are stock and
  securities (including real estate investment
  trusts and regulated investment companies), the
  partnership will be treated as an investment
  partnership

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Contribution Exceptions

• Certain contributions of encumbered property
• If relief of debt exceeds basis, gain occurs
• 752(a) - Any increase in a partners share of
  partnership liabilities, or any increase in a
  partners individual liabilities due to
  assumption by the partner is considered a
  contribution of money by the partner to the
  partnership
• 752(b) - Any decrease in a partners share of
  partnership liabilities or any decrease in a
  partners individual liabilities due to
  assumption by the partnership is considered a
  distribution of money to the partner by the
  partnership

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Contribution Exceptions

• Certain contributions of encumbered property
• 752(c) - Only taken into consideration to the
  extent of the fair market value of the property
  it encumbers
• 731(a)(1) - In the case of a distribution by a
  partnership to a partner, gain shall not be
  recognized to such partner, except to the extent
  that any money distributed exceeds the adjusted
  basis of such partners interest in the
  partnership immediately before the distribution

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Contribution Exceptions

• Certain contributions of encumbered property
• Rev Rul 84-15 - A partner who recognizes gain
  upon the contribution of encumbered property to a
  partnership, does not increase the basis of
  his/her partnership interest to reflect the gain
  and the partnership does not increase the
  adjusted basis of the contributed property to
  reflect such gain
• 731(a) - In the case of a distribution by a
  partnership to a partner, any gain or loss
  recognized shall be considered a gain or loss
  from the sale or exchange of a partnership
  interest

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Contribution Exceptions

• Case Study Recourse Liabilities
• Ann and Margaret form an equal partnership. Ann
  contributes 50,000 cash. Margaret contributes
  land with a FMV of 90,000 and adjusted basis of
  10,000, subject to a 40,000 recourse liability.
  What is Ann and Margarets initial tax basis in
  the partnership? Will either partner recognize
  gain on contribution?

9
Contribution Exceptions

• Case Study Nonrecourse Liabilities
• James and Dean form an equal partnership. James
  contributes 20,000 cash. Dean contributes land
  with a fair market value of 50,000 and an
  adjusted basis of 10,000, subject to a 30,000
  nonrecourse liability. The Partnership has no
  other liabilities and no 1.704-2(d)(1) minimum
  gain. What is James and Deans initial tax basis
  in the partnership? Will either partner recognize
  gain on contribution?

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Exceptions to GeneralNonrecognition Rule

• Contribution of encumbered depreciation recapture
  property
• Gain will be characterized as ordinary
• 1245(b)(3) and 1250(d)(d) If basis of
  property in the hands of the recipient is
  determined by reference to the basis in the hands
  of the transferor due to 721 or 731, then the
  recapture gain shall not exceed the recognized
  gain on the transfer
• 1.1245-2(c)(2) and 1.1250-3(c)(3) The
  contributed property continues to be subject to
  depreciation recapture in the hands of the
  partnership

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Contribution Exceptions

• Case Study 1245 - Property Contribution
• In exchange for a 50 partnership interest, Ms.
  Hepburn contributes a film reel subject to 1245
  with a FMV of 50,000, adjusted basis of 20,000
  and recomputed basis under 1245 of 40,000. The
  property is subject to a recourse liability of
  45,000. Is any gain recognized on the
  contribution? What is the character of the gain?

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Contribution Exceptions

• Contribution of services current rules
• Capital and profits interest have different
  treatment
• 1.721-1(b)(1) - To the extent any of the
  partners gives up any part of his right to be
  repaid his contributions (as distinguished from a
  share in partnership profits) in favor of another
  partner as compensation for services, 721 does
  not apply

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Contribution Exceptions

• Contribution of services current rules (Contd)
• Rev Proc 93-27 - The receipt of a partnership
  profits interest for services is not a taxable
  event so long as the person receives that
  interest either as a partner or in anticipation
  of becoming one. This rule is not applicable if
• The profits interest relates to a substantially
  certain and predictable stream of income from
  partnership assets
• The partner disposes of the profits interest
  within two years of receipt
• The profits interest is a limited partnership
  interest in a publicly traded partnership

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Contribution Exceptions

• Contribution of services current rules (Contd)
• Rev Proc 2001-43 - If service provider receives
  interest for providing services to or on behalf
  of partnership, IRS wont treat receipt of
  interest as taxable event for either partner or
  partnership. Determination of whether interest
  qualifies as profit interest is measured at time
  interest is granted even if interest is
  substantially nonvested within meaning of
  1.83-3(b), and grant of interest or event that
  causes interest to be substantially vested wont
  be treated as taxable event.
• 83(b) - Election not required

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Contribution Exceptions

• Contribution of services current rules (Contd)
• 1.83-3(b) - Property is substantially nonvested
  when it is subject to a substantial risk of
  forfeiture. Property is substantially vested when
  it is either transferable or not subject to a
  substantial risk of forfeiture

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Exceptions to GeneralNonrecognition Rule

• Contribution of services proposed regulations
• No differential between profits and capital
  interest
• Proposed 1.721-1(b)(1) The transfer of a
  partnership interest to a person in connection
  with the performance of services constitutes a
  transfer of property to which IRC 83 and
  regulations apply

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Contribution Exceptions

• Contribution of services proposed regulations
• Recipient partner will recognize compensation
  income under 83(a) equal to the excess of the
  fair market value of the partnership interest
  received over any amount the recipient paid for
  the interest
• Service providers receipt of profit or capital
  interest is taxable depending on whether the
  interest is substantially vested and , if not,
  whether and 83(b) election is made

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Contribution Exceptions

• Contribution of services proposed regulations
  (Contd)
• Proposed 1.83-3(l) - A partnership and all of
  its partners may elect a safe harbor under which
  the fair market value of a partnership interest
  that is transferred in connection with the
  performance of services is treated as being equal
  to the liquidation value of that interest
• Liquidation value equals the amount of cash the
  partner would receive with respect to the
  partnership interest if the partnership sold all
  its assets for cash at fair market value
  immediately after the actual transfer of the
  interest, then liquidated
• When Proposed Reg 1.721-1 is finalized, Notice
  2005-43 will obsolete Rev Procs 93-27 and
  2001-43

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Contribution Exceptions

• 707(a)(2)(B) - Disguised sales a contribution
  of property will be treated as a sale when
• There is a direct or indirect transfer of
  property, including money, by a partner to a
  partnership
• There is a related direct or indirect transfer of
  property, including money, by the partnership to
  that partner and
• When viewed together both transfers are properly
  characterized as a sale or exchange

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Exceptions to GeneralNonrecognition Rule

• 1.707-3(c) Transfers made within two years
  presumed to be a sale
• If within a two year period a partner transfers
  property to a partnership and the partnership
  transfers money or other consideration to the
  partner, the transfers are presumed to be a sale
  of property to the partnership
• Form 8275 disclosure may be required

21
Contribution Exceptions

• Case Study
• HoldCo (a C corporation) owns an option to
  purchase a desirable piece of development
  property. HoldCo does not have the funds to
  facilitate the purchase
• HoldCo finds an investor who does have the cash
  to purchase the real estate and is interested in
  funding the development

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Contribution Exceptions

• Case Study (Contd)
• HoldCo contributes the purchase option to LLC on
  March 31, 2007. The FMV of the purchase option as
  stated in the partnership agreement is
  1,013,000. HoldCo has a basis in the purchase
  option of 800,000.
• HoldCo incurs some cash flow problems. On July
  31, 2008, LLC distributes 688,000 cash to
  HoldCo.
• What are the tax implications of the above
  transactions?

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Contribution Exceptions

• 707(b)(2) - Gains treated as ordinary income
• If property is sold (or deemed sold) to a
  partnership by a person who, directly or
  indirectly, owns more than 50 of the
  partnership, or
• If property is sold (or deemed sold) between two
  partnerships in which the same persons own,
  directly or indirectly, more than 50 of the of
  the capital or profit interests of the
  partnership, and
• The property in the hands of the recipient will
  not be a capital asset (1221)
• Then the gain recognized will be characterized as
  ordinary income

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Distributions

• General rule
• 731(a) Nonrecognition of gain or loss on
  distribution
• Gain shall not be recognized to partner except to
  the extent any money distributed exceeds the
  adjusted basis of the partners partnership
  interest immediately before the distribution
• No gain or loss recognized on property
  distributions
• Loss shall not be recognized to partner except
  upon a liquidating distribution of the partners
  partnership interest where no property other than
  money, unrealized receivables ( 751(c)), and
  inventory (751(d)) are distributed

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Distribution Exceptions

• Tainted assets
• 735(a) When distributed property is later sold
• When a partner later sells unrealized receivables
  ( 751(c)) received via partnership distribution,
  the resulting gain or loss will be treated as
  ordinary
• When a partner later sells inventory (751(d))
  received via partnership distribution, the
  resulting gain or loss will be treated as
  ordinary if the inventory is sold within five
  years of distribution

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Distribution Exceptions

• 704(c)(1)(B) Precontribution gain triggered by
  later distribution
• Gain or loss to partner who contributed asset
  with precontribution gain is triggered when
• Partner contributes an asset with FMV in excess
  of basis
• The Partnership distributes the precontribution
  asset to another partner within seven years of
  its initial contribution

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Distribution Exceptions

• 704(c)(1)(B) Precontribution gain triggered by
  later distribution (Contd)
• Gain or loss is computed based on gain that would
  have been allocated to partner if partnership had
  sold precontribution asset at fair market value
  at time of distribution
• Character of gain or loss is based on the
  character had the partnership sold the
  precontribution asset to the recipient
• Basis of initial contributing partners
  partnership interest is adjusted by gain or loss
  recognized
• Distributed propertys basis is adjusted for gain
  or loss recognized

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Distribution Exceptions

• Case Study
• Fred and Barney form a partnership. Fred
  contributes 10,000 cash and a rock with a fair
  market value of 10,000 and adjusted basis of
  4,000 in exchanges for a 25 interest in the
  partnership. Barney contributes 60,000 for a 75
  partnership interest. Five years later, the
  Partnership distributes the rock to Barney in a
  current distribution. The rock is now valued at
  11,000. Fred originally purchased the rock as an
  investment. The Partnership holds the rock as
  inventory available for sale.

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Distribution Exceptions

• Case Study (Contd)
• What is the precontribution gain?
• How much gain is recognized by Fred?
• What is the character of the gain?

30
Distribution Exceptions

• 737 Precontribution gain triggered by later
  distribution
• Gain to partner who contributed asset with
  precontribution gain is triggered when
• One partner contributes an asset with FMV in
  excess of basis within the previous seven years
• That partner receives a distribution of another
  partnership asset within that seven year period

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Distribution Exceptions

• 737 Precontribution gain triggered by later
  distribution (Contd)
• Gain recognition is lesser of
• Precontribution gain
• Excess distribution
• The fair market value of property other than
  money distributed less the adjusted basis of the
  partners partnership interest immediately before
  the distribution minus any money included in the
  distribution
• Gain is separately recognized on cash
  distribution under 731(a)
• Basis of recipient partners partnership interest
  is increased by gain recognized
• Partnerships basis in property contributed by
  recipient partner is increased by the partners
  737 gain

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Distribution Exceptions

• Case Study
• Ginger contributed her modeling portfolio (value
  1,000 and adjusted basis 600) to a partnership
  in exchange for 1/3 interest in partnership
  profits, losses and capital. Six years later, the
  Partnership still owns Gingers modeling
  portfolio and its value has increased to 1,200.
  During year six the Partnership distributes Mary
  Anns modeling portfolio (value 800) to Ginger.
  Gingers adjusted basis in the partnership is
  still 600.

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Distribution Exceptions

• Case Study (Contd)
• What is the precontribution gain?
• What is the excess distribution?
• How much gain does Ginger recognize from the
  distribution of Mary Anns modeling portfolio to
  Ginger?
• What is Gingers basis in the partnership?
• What is the Partnerships basis in Gingers
  modeling portfolio?

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Distribution Exceptions

• Case Study
• Same scenario as previous except after receiving
  Gingers contribution of her modeling portfolio,
  the Partnership purchased Mary Anns modeling
  portfolio for 900 and borrowed 900 in
  nonrecourse debt to facilitate the purchase. Six
  years after Gingers initial contribution, the
  Partnership distributes Mary Anns modeling
  portfolio (value 900), the related debt and 200
  cash to Ginger. There are no tier 1 or tier 2
  nonrecourse debt allocations, so the debt is
  allocated in accordance with the partners
  profits interest (1/3)

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Distribution of Partnership Interests

• Primary methods of disposition of a partnership
  interest
• Sale or exchange
• Abandonment or foreclosure
• Transfer to a corporation
• Gift or charitable contribution
• Nontaxable exchange

36
Sale or Exchange

• Sale or exchange
• Sales to third parties, other partners, or
  partial sales are all treated the same
• Steps in determining tax implications
• Determine the overall gain or loss
• Determine the character of the gain or loss
• Determine the holding period for the partnership
  interest

37
Sale or Exchange

• Overall gain or loss
• Amount realized (cash plus FMV of property)
  including debt relief
• Less adjusted basis including debt assumed
• Equals gain or loss on disposition of partnership
  interest

38
Sale or Exchange

• Character of the gain or loss
• 741 - Gain or loss recognized by the transferor
  partner shall be considered as gain or loss from
  the sale or exchange of a capital assets, except
  as otherwise provided in 751
• 751(a) - The money or fair market value of
  property received by a selling partner in
  exchange for all or part of his partnership
  interest attributable to unrealized receivables
  and inventory is considered an amount realized
  from the sale or exchange or property other than
  a capital asset

39
Sale or Exchange

• Character of the gain or loss (Contd)
• Since sale or exchange, no requirement that
  inventory be substantially appreciated
• Partnership required to file Form 8308 when
  transfer includes 751(a) property
• 751(d)(3) - Inventory includes any property held
  by the partnership which, if held by the selling
  partner would be considered inventory

40
Sale or Exchange

• Holding period
• If partnership interest was acquired by purchase,
  contribution of cash or contribution of
  non-capital assets
• Holding period begins the day after acquisition
  of the partnership interest
• If partnership interest was acquired by
  contribution of 1221 and/or 1231 assets
• Pre-contribution holding period tacks
• 1223(1)
• 1.1223(b) - Holding period is determined based
  on FMV of partnership interest received in the
  transaction to which the holding period relates
  divided by the FMV of the entire partnership
  interest

41
Sale or Exchange

• Case Study
• The Three Stooges Partnership is in the retail
  computer business. Each partner has an equal
  interest in the partnerships profits, losses and
  capital. On January 1, 2009, Moe approached Larry
  regarding the possible sale of Larrys
  partnership interest. On this date, the
  partnership had the following balance sheet.

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Sale or Exchange

• Case Study (Contd)

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Sale or Exchange

• Case Study (Contd)
• The equipment depreciation is subject to 1245
  recapture. The building has been held over 12
  months and has been depreciated on a straight
  line basis. Larry received his initial
  partnership interest in exchange for a 10,000
  contribution of cash five years ago.
• What is the tax implication to Larry if Moe pays
  200,000 cash for Larrys partnership interest?
• If Larry is a dealer in real estate, how does the
  result change for Larry?

44
Sale or Exchange

• Installment sale of partnership interest
• Defers recognition of gain
• Income recognized at time of sale
• Ordinary income related to inventory
• Ordinary income from 1245 recapture
• May allow buyer to purchase partnership interest
  with future partnership distributions

45
Abandonment

• Character of loss
• Is the partner relieved of any debt due to
  abandonment?
• Partners share of liabilities 0
• Ordinary loss
• Partners share of liabilities gt 0
• Sale or exchange

46
Abandonment

• Rev Rul 93-80
• Under 1.165-2 absent a sale or exchange a loss
  that results from the abandonment or
  worthlessness of nondepreciable property is an
  ordinary loss even if the abandoned or worthless
  asset is a capital asset (such as a partnership
  interest)

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Abandonment

• Rev Rul 93-80 (Contd)
• 731 and 741 apply to any transaction which the
  partner receives an actual distribution of money
  or property from the partnership. There
  provisions likewise apply to any transaction in
  which a partner is deemed to receive a
  distribution from the partnership (e.g. 752(b)).
  Thus, whether there is an actual distribution or
  a deemed distribution, the transaction is treated
  as a sale or exchange of the partnership
  interest, and any loss resulting from the
  transaction is capital (except as provided in
  751(b)

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751(b)

• 751(b) Certain distributions treated as sales or
  exchanges
• Applies to distributions that alter the partners
  interests in unrealized receivables and
  substantially appreciated inventory
• Substantially appreciated FMV gt 120 adjusted
  basis
• To the extent distribution is taxable and related
  to these items, gain or loss will be ordinary

49
751(b)

• Example
• The assets of Mary Tyler Moore partnership
  consist of 90,000 cash and inventory with a FMV
  of 90,000 and an adjusted basis of 45,000. All
  partners have equal profit, loss and capital
  interests. Tyler has an adjusted basis of 45,000
  in his partnership interest. If Tyler receives a
  liquidating distribution of 60,000 cash, the
  distribution reduces his 30,000 interest in the
  value of the partnerships substantially
  appreciated inventory to 0. Therefore 751(b)
  applies.

50
751(b)

• Tyler received a current distribution of his
  30,000 interest in partnership inventory.
  Tylers share of the inventorys basis was
  15,000 (results in 15,000 ordinary income
  recognition to Tyler)
• Tyler is treated as selling his interest in the
  hypothetically distributed inventory back to the
  partnership for 30,000 (partnerships basis in
  inventory is now 60,000 30,000 AB from
  inventory not sold 30,000 from hypothetical
  repurchase)
• The remaining 30,000 distributed to Tyler is
  taxed under the general distribution rules (0
  gain left to be recognized therefore capital gain
  is nil)

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Abandonment

• How does 752 and 751(b) apply in an abandonment
  situation?

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