PARTNERSHIP FORMATIONS

1
PARTNERSHIP FORMATIONS

• PATRICK HENNESSEE

2
OVERVIEW

• PROPERTY CONTRIBUTIONS
• BASIC EFFECT OF LIABILITIES
• On Outside Basis
• Encumbered Property
• CONTRIBUTIONS OF SERVICES
• Services for a Capital Interest
• Services for a Profits Interest
• Organization Syndication Costs

3
Start putting the pieces of the puzzle together
4
Property Contributions

• No gain or loss for a contribution of property
  in exchange for a partnership interest -- 721
• Property?
• Carryover basis rules -- 722 723
• Tangent issues
• 724 - Preserves character of BIG/BIL
• 704(c) - Allocates BIG/BIL

5
Section 721
(a) General rule No gain or loss shall be
recognized to a partnership or to any of its
partners in the case of a contribution of
property to the partnership in exchange for an
interest in the partnership. (b) Special
rule Subsection (a) shall not apply to gain
realized on a transfer of property to a
partnership which would be treated as an
investment company (within the meaning of section
351) if the partnership were incorporated. (c)
Regulations relating to certain transfers to
partnerships. -- The Secretary may provide by
regulations that subsection (a) shall not apply
to gain realized on the transfer of property to a
partnership if such gain, when recognized, will
be includible in the gross income of a person
other than a United States person. (d) Transfers
of intangibles- "For regulatory authority to
treat intangibles transferred to a partnership as
sold, see section 367(d)(3)."
6
Section 722
The basis of an interest in a partnership
acquired by a contribution of property, including
money, to the partnership shall be the amount of
such money and the adjusted basis of such
property to the contributing partner at the time
of the contribution increased by the amount (if
any) of gain recognized under section 721(b) to
the contributing partner at such time.
7
Section 723
The basis of property contributed to a
partnership by a partner shall be the adjusted
basis of such property to the contributing
partner at the time of the contribution increased
by the amount (if any) of gain recognized under
section 721(b) to the contributing partner at
such time.
8
724- Character of gain or loss on contributed
unrealized receivables, inventory items, and
capital loss property
(a) Contributions of unrealized receivables In
the case of any property which-- (1) was
contributed to the partnership by a partner,
and (2) was an unrealized receivable in the hands
of such partner immediately before such
contribution, any gain or loss recognized by the
partnership on the disposition of such property
shall be treated as ordinary income or ordinary
loss, as the case may be. (b) Contributions of
inventory items In the case of any property
which-- (1) was contributed to the partnership by
a partner, and (2) was an inventory item in the
hands of such partner immediately before such
contribution, any gain or loss recognized by the
partnership on the disposition of such property
during the 5-year period beginning on the date of
such contribution shall be treated as ordinary
income or ordinary loss, as the case may be.
9
724-Continued
(c) Contributions of capital loss property In
the case of any property which-- (1) was
contributed by a partner to the partnership, and
(2) was a capital asset in the hands of such
partner immediately before such contribution, any
loss recognized by the partnership on the
disposition of such property during the 5-year
period beginning on the date of such contribution
shall be treated as a loss from the sale of a
capital asset to the extent that, immediately
before such contribution, the adjusted basis of
such property in the hands of the partner
exceeded the fair market value of such property.
10
724-Continued
(d) Definitions For purposes of this
section-- (1) Unrealized receivable The term
"unrealized receivable" has the meaning given
such term by section 751(c) (determined by
treating any reference to the partnership as
referring to the partner). (2) Inventory item The
term "inventory item" has the meaning given such
term by section 751(d) (determined by treating
any reference to the partnership as referring to
the partner and by applying section 1231 without
regard to any holding period therein
provided). (3) Substituted basis property (A) In
general If any property described in subsection
(a), (b), or (c) is disposed of in a
nonrecognition transaction, the tax treatment
which applies to such property under such
subsection shall also apply to any substituted
basis property resulting from such transaction. A
similar rule shall also apply in the case of a
series of non-recognition transactions. (B)
Exception for stock in C corporation Subparagraph
(A) shall not apply to any stock in a C
corporation received in an exchange described in
section 351.
11
704(C)(1)(A)
(c) Contributed property. -- (1) In general. --
Under regulations prescribed by the Secretary
-- (A) income, gain, loss, and deduction with
respect to property contributed to the
partnership by a partner shall be shared among
the partners so as to take account of the
variation between the basis of the property to
the partnership and its fair market value at the
time of contribution, and (B) ..
12
Problem - Page 28-29

13
Effect of Liabilities on O/S Basis

• Concept O/S Basis Liab. Capital
• Sec. 752(a) 722
• Increase in partners share of liabilities
• cash contribution ()
• Sec. 752(b) 705(a) 733
• Decrease in partners share of liabilities
• cash distribution (-)

14
752 Treatment of Certain Liabilities

• (a) Increase in partner's liabilities
• Any increase in a partner's share of the
  liabilities of a partnership, or any increase in
  a partner's individual liabilities by reason of
  the assumption by such partner of partnership
  liabilities, shall be considered as a
  contribution of money by such partner to the
  partnership.
• (b) Decrease in partner's liabilities
• Any decrease in a partner's share of the
  liabilities of a partnership, or any decrease in
  a partner's individual liabilities by reason of
  the assumption by the partnership of such
  individual liabilities, shall be considered as a
  distribution of money to the partner by the
  partnership.
• (c) Liability to which property is subject
• For purposes of this section, a liability to
  which property is subject shall, to the extent of
  the fair market value of such property, be
  considered as a liability of the owner of the
  property.
• (d) Sale or exchange of an interest .

15
Partners Share of Liabilities

• Depends on
• Status of Partner (General or Limited)
• Nature of liability (Recourse/Nonrecourse)
• Recourse Liabilities -
• bear economic risk of loss
• required to pay if partnership not able to
• Test Who would have to pay if all liabilities
  were due and all assets are worthless

16
Basics of Liabilities Sec. 752
RECOURSE NON-RECOURSE
Partners share Portion he bears economic risk
of loss. (Who is obligated if all debt is paid
and assets are worthless?)
No partner bears economic risk of loss. Neither
general or limited partner have
personal liability (Both General Limited) All
partners share according to partners profits
interest
General Partnership Goes to who bears the burden
of economic risk of loss. Limited
Partnership Only up to what the partner is
committed to contribute
17
General Rules - Summary

• Recourse Liabilities
• General Partners share according to loss ratios
• Limited Partners - None - (unless obligated to
  make future contribution)
• Nonrecourse Liabilities
• All partners (general and limited) share based on
  profits ratios

Problem - Page 38
18
Contributions of Encumbered Property

• Relieved of liability?
• distribution of
• ROC to extent of basis
• Reduces basis ( but not below zero)
• Assume liability?
• Cash contribution
• Increases basis
• Recourse Liability in excess of basis
• Can cause a gain to be recognized

19
Non-Recourse Liabilities with Encumbered Property

• 1st - Allocate minimum gain to contributing
  partner - then allocate balance according to
  profits ratio
• Amount of NR debt
• - Propertys basis
• Minimum Gain
• Generally, no gain or loss will be recognized

20
Summary - Encumbered Property
Recourse Non-Recourse
Allocate to Profits Interest Precontribution
Gain/Loss Allocate to contributing partner
--S. 704(c). Liab. gt Basis (special) Liab.
xxxx - A/B - xxxx Min. Gain xxx to
C Ptner Balance allocated under general rules
(profits rations)
Allocate to those who bear economic risk
of loss. Constructive cash distribution
greater than basis? Then, gain to contributing
partner Remember, no negative basis
21
Non-recourse Liability in excess of propertys
basis
Example on page 40 of text for
A Adjusted basis of contributed Property
10,000 Less Liability relieved of Total
liability 30,000 Less min.
gain - 20,000 Less proper
share of remainder of liability -
5,000 Amount of liability relieve of
- 5,000 The contributing partners outside
basis 5,000 This means that A is allocated
25,000 of the debt and B is allocated 5,000 of
the debt
22
Problem - Page 42
23
Services for a Capital Interest

• Service Partner Ordinary income (fmv of
  interest)
• Sec. 83 determines the timing of income
• Restrictions and the Sec 83(b) election
• Partnership
• Deduct or capitalize amount paid
• May have recognized gain if appreciated property
  involved (See McDougal)

Problem - Page 51
24
McDougal,62 T.C. 720
The Players
McDougal

(Horse breeder and rancher)
McDougal buys Iron Card for 10,000.
25
McDougal,62 T.C. 720
The Outcome

• McClanahans remedy worked and Iron Card became
  a
• racing success. McDougal was offered 60,000
  for
• horse
• But, McDougal did not sell, he transferred a 50
  
• interest in Iron Card to McClanahan (the deal)
• Iron Card is injured and then used as a breeder

26
McDougal,62 T.C. 720
The Tax Bite

• A partners ship was formed
• McDougal contributed Iron Card -- no gain
  recognized
• McClanahan received a partnership interest in
  capital
• for services rendered ordinary income of fmv
  of
• interest received
• McDougal deemed to have a gain on the transfer
  of an
• appreciated asset.
• Basis determined by Section 722 and 723

27

McDougal,62 T.C. 720
The Sad Conclusion - Ignore depreciation
1. McDougal transferred the horse to the
partnership for a 50 interest in the
partnership -tax free (721) 2. McDougals basis
in the partnership was 10,000, the basis of
the horse 3. McClanahan was a service partner and
recognizes 30,000 of ordinary income (fmv of
interest received) This is his basis in the
partnership. McDougal gets an ordinary
deduction for the 30,000 (Sec. 162) 4. McDougal
must recognize a 25,000 gain on the
disposition of 1/2 of Iron Card (30,000 -
5,000) 5. McDougals outside basis
10,000 25,000 - 30,000 5,000
28

McDougal,62 T.C. 720
Inside basis of Iron Card - Ignore depreciation
Contributed half 5,000
Deemed purchase half 30,000
Total 35,000
29
Services for a Profits Interest

• The Starting Point - Reg Sec 1.721-1
• A bit of history - Sol Diamond
• Rev. Proc. 93-27
• Generally tax free receipt
• Except
• Substantially certain and predictable income from
  partnership assets
• Disposes of interest within 2 years
• Limited partnership interest in a publicly traded
  partnership
• Problem- page 64

30
Organization Expenses - S. 709

• Incident to creation of partnership
• Chargeable to capital account
• Would be amortizable over partnership life
• Law
• Capitalize and amortize over 60 mo.s
• Beginning with month partnership begins business

31
Syndication Costs

• Fees related to syndication and selling the
  partnership interest - promote costs
• Must capitalize and leave on the books - no
  amortization

32
709 - Treatment of organization and syndication
fees
(a) General rule Except as provided in subsection
(b), no deduction shall be allowed under this
chapter to the partnership or to any partner for
any amounts paid or incurred to organize a
partnership or to promote the sale of (or to
sell) an interest in such partnership.
Problem - Page 66
33
709 - Continued
(b) Amortization of organization fees (1)
Deduction Amounts paid or incurred to organize a
partnership may, at the election of the
partnership (made in accordance with regulations
prescribed by the Secretary), be treated as
deferred expenses. Such deferred expenses shall
be allowed as a deduction ratably over such
period of not less than 60 months as may be
selected by the partnership (beginning with the
month in which the partnership begins business),
or if the partnership is liquidated before the
end of such 60-month period, such deferred
expenses (to the extent not deducted under this
section) may be deducted to the extent provided
in section 165.
34
709 - Continued
(2) Organizational expenses defined The
organizational expenses to which paragraph (1)
applies, are expenditures which-- (A) are
incident to the creation of the partnership (B)
are chargeable to capital account and (C) are of
a character which, if expended incident to the
creation of a partnership having an ascertainable
life, would be amortized over such life.