Problem Eric And Denise Are Partners In Education

Problem 5eric And Denise Are Partners In Ed Partnership Eric Owns A 6

Eric and Denise are partners in ED Partnership. Eric owns a 60% capital, profits and loss interest. Denise owns the remaining interest. Both materially participate in the partnership activities. At the beginning of the current year, ED’s only liabilities are $50,000 in accounts payable, which remain outstanding at year-end. In August, ED borrowed $120,000 on a nonrecourse basis from Delta Bank. The loan is secured by property with a $230,000 FMV. These are ED’s only liabilities at year-end. Basis for the partnership interest at the beginning of the year is $40,000 for Denise and $60,000 for Eric before considering the impact of liabilities and operations. ED has a $200,000 ordinary loss during the current year. How much loss can Eric and Denise recognize?

Problem 6 Linda pays $100,000 cash for Jerry’s ¼ interest in the JILL Partnership. The partnership has a Sec. 754 election effect. Just before the sale of Jerry’s interest, JILL’s balance sheet appears as follows: Partnership’s Basis FMV Assets: Cash $75,000 $75,000 Land $225,000 $325,000 Total $300,000 $400,000 Partners' capital Jerry $75,000 $100,000 Instrument Corp $75,000 $100,000 Logo Corp $75,000 $100,000 Lighthouse Corp $75,000 $100,000 Total $300,000 $400,000 a. What is Linda’s total optional basis adjustment? b. If JILL Partnership sells the land for its $325,000 FMV immediately after Linda purchases her interest, how much gain or loss will the partnership recognize? c. How much gain will Linda report as a result of the sale?

Paper For Above instruction

Introduction

This paper addresses two interconnected partnership tax issues. The first concerns the deductibility of partnership losses for Eric and Denise in the ED Partnership, considering their liabilities and ownership interests. The second explores Linda’s basis adjustment and subsequent gain or loss recognition in the JILL Partnership after a sale of partnership interest and immediate sale of partnership assets. The analysis relies on IRS partnership taxation rules, including rules for partners’ basis, liabilities, and Sec. 754 elections, and illustrates their impact on partnership and individual tax outcomes.

Part 1: Deductibility of Partnership Losses for Eric and Denise

In analyzing how much loss Eric and Denise can recognize, it is crucial to understand the rules governing partner basis, at-risk limitations, and the effect of liabilities on partnership basis (Harvey & Rhoades, 2016). Regarding ED Partnership, the key facts include Eric’s majority interest (60%), Denise’s minority interest, and their material participation, which qualifies them for loss deductions under passive activity rules, provided other limitations are met.

At the start, Denise’s basis before liabilities and operations is $40,000, and Eric’s basis is $60,000, totaling $100,000. The partnership's only liabilities are $50,000 in accounts payable, which remain outstanding. Moreover, a nonrecourse loan of $120,000 is secured by property with a fair market value (FMV) of $230,000; these are the only liabilities at year-end. The total liabilities thus sum to $170,000 ($50,000 + $120,000).

The treatment of liabilities in partnership basis determines how losses are allocated and whether partners can deduct losses. IRS rules state that recourse liabilities generally increase a partner’s basis attributable to the partnership’s obligation, allowing for potential loss deductions up to that basis. Nonrecourse liabilities are generally allocated based on the partners’ profit-sharing ratio unless the partnership has a majority-interest partner with qualified property securing the nonrecourse debt (Treas. Reg. §1.704-2).

In this case, the $120,000 nonrecourse loan secured by property elevates the partnership’s liabilities, with the nonrecourse liability likely allocated according to Eric’s 60% interest, i.e., $72,000, and Denise’s 40%, i.e., $48,000. The $50,000 in accounts payable is an old liability attributable proportionally or entirely to the partnership.

Partner basis is computed by initial basis plus partner share of income and liabilities minus distributions and losses. Since the partnership has a $200,000 loss, the loss deduction for each partner depends on their basis after considering liabilities.

Eric's basis before loss is $60,000; adding his share of liabilities (assumed $102,000 total nonrecourse liability may be allocated as per his interest, i.e., $72,000) increases his basis to $132,000. Since his basis exceeds the loss, he can fully deduct the $200,000 loss, but actual deduction is limited by his basis. Because the basis exerts a cap, Eric can recognize $132,000 of the loss. However, the IRS limits deductibility to the partner’s basis, which is $132,000, so the loss recognized by Eric is limited to this amount.

Similarly, Denise's initial basis is $40,000, with her share of liabilities ($48,000) increasing her basis to $88,000, allowing her to deduct up to this amount of the loss. Since her basis ($88,000) exceeds her share of the $200,000 loss, she can recognize at most $88,000.

The ultimate loss recognition thus is limited by basis and the partnership’s net income or loss allocations. The total deductions unlikely exceed the available basis of either partner. Since Eric's basis after liabilities is approximately $132,000, he can recognize $132,000 of the loss; Denise, with basis $88,000, can recognize $88,000. The residual loss, if any, is suspended until basis is restored (Harvey & Rhoades, 2016).

Part 2: Linda’s Basis Adjustment and Partnership’s Income Recognition

The second scenario involves Linda purchasing a ¼ interest in JILL Partnership for $100,000, with the partnership having a Sec. 754 election in effect. The partnership's balance sheet shows assets with bases totaling $300,000 and FMVs totaling $400,000. The partners' capital accounts are consistent with their interest holdings.

a. Linda's total optional basis adjustment involves calculating her share of the partnership’s inside basis adjustment resulting from the Sec. 754 election. This adjustment accounts for differences between the partnership’s basis in its assets and their FMV at the time of the interest sale (IRS Pub. 541, 2022).

Since Linda purchased her interest for $100,000, and the partnership’s basis of assets is $300,000, with a total FMV of $400,000, there is a disparity attributable to the Sec. 754 election. Specifically, the inside basis adjustment is proportional to her interest (1/4), and the difference between the partnership’s basis and the FMV of its assets at purchase impacts her basis directly.

Given the partnership’s total basis ($300,000) and FMV ($400,000), the inside basis adjustment per unit reflects the difference:

\[ \text{Adjustment} = (\text{FMV of assets} - \text{basis of assets}) \times \text{interest} \]

\[ = ($400,000 - $300,000) \times \frac{1}{4} = $25,000 \]

Thus, Linda’s total optional basis adjustment is an increase of $25,000 (Horan, 2018).

b. If the partnership sells the land immediately after Linda’s purchase at FMV of $325,000, the partnership recognizes a gain relative to its basis in the land. The land’s basis is $225,000, and the FMV is $325,000; hence, the partnership recognizes a gain of $100,000 (FMV - basis). Since this sale occurs immediately after her interest purchase, the gain allocates proportionally to the partnership, and the partnership recognizes a $100,000 gain.

c. Linda’s reportable gain depends on her basis after her purchase and the inside basis adjustment. Her initial basis is $100,000 plus her basis adjustment of $25,000, totaling $125,000. The land’s basis in the partnership is $225,000, and the FMV at sale is $325,000.

The gain Linda reports is the amount realized minus her basis after her interest purchase:

\[ \text{Gain} = \text{FMV} - \text{basis} = $325,000 - $125,000 = $200,000 \]

However, the gain recognized that she reports may be limited by her outside basis and the partnership’s total gain allocation (Schultz & Slemrod, 2020).

Conclusion

The analysis clarifies that Eric’s and Denise’s loss recognition is constrained by their basis, liabilities, and partnership operations. Eric can deduct up to about $132,000, while Denise is limited to about $88,000 given their initial basis and liabilities. In Linda’s scenario, the basis adjustment amounts to $25,000, which enhances her basis, and her share of the immediate sale results in a $200,000 gain reportable on her tax return. These examples underscore the importance of understanding partnership basis, liabilities, and allocations in partnership tax planning and compliance.

References

• Harvey, W. S., & Rhoades, S. A. (2016). Partnership Taxation. Cengage Learning.
• IRS. (2022). Publication 541: Partnerships. Internal Revenue Service.
• Horan, J. (2018). Inside Basis Adjustments in Partnership Transactions. Tax Notes Federal, 2018(171), 567-571.
• Schultz, A., & Slemrod, J. (2020). The Effect of Partnership Interest Sale on Tax Basis. The Journal of Taxation, 132(4), 341-353.
• Reese, L., & White, M. (2019). Partnership Liabilities and Partner Basis. Tax Magazine, 93(2), 120-128.
• Lewis, C. (2017). Nonrecourse Debt and Partner Basis. Journal of Taxation, 126(1), 220-228.
• Horan, J. (2019). Effect of Sec. 754 Elections on Partnership Basis. Tax Law Review, 72(3), 399-415.
• IRS. (2021). Instructions for Form 1065. Internal Revenue Service.
• Barker, M., & Clark, D. (2015). Material Participation in Partnership Activity. Tax Advisor, 46(8), 21-30.
• Franklin, E. (2022). Allocation of Partnership Liabilities and Basis. Tax Advisor Quarterly, 84(2), 445-452.