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CPA Review Partnership Tax Partnerships File 1065 Information partnership pays no taxes tax items flow through to partner’s income tax returns nature and character of items remain the same (e.g. ordinary, capital gain) Consequences of Partnership Formation

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cpa review

CPA Review

Partnership Tax

partnerships
Partnerships
  • File 1065 Information
    • partnership pays no taxes
    • tax items flow through to partner’s income tax returns
    • nature and character of items remain the same (e.g. ordinary, capital gain)
consequences of partnership formation
Consequences of Partnership Formation
  • General Rule: No gain or loss to partner
  • No gain or loss to partnership
  • Partner’s basis in partnership interest = substituted basis of contributed property
partnership formation
Partnership Formation
  • Partnership’s basis in property received = carryover of partner’s basis
  • Gain deferred until taxable disposition of:
    • property by partnership, or
    • partnership interest by partner
partnership formation5
Partnership Formation
  • Exception: Partner must recognize gain :
    • If property is contributed subject to a liability and reduction in partner’s liability exceeds his partnership basis
      • generally capital unless depre. recap.
    • If partnership interest is received in exchange of services
    • If partnership would be investment company if incorporated
basis issues
Basis Issues

Outside Basis Inside Basis

Partner’s basis Partner’s basis

in partnership in share of

interest partnership assets

General rule: when partnership is formed, inside basis = outside basis

partner s outside basis
Partner’s Outside Basis
  • Original Basis
  • + subsequent capital contributions
  • + share of ordinary income, capital gains , other income items
  • + share of tax exempt income
  • + share of excess depletion
  • - money and property distributions
  • - share of ordinary loss, special expense items, nondeductible items
partner s outside basis8
Partner’s Outside Basis
  • Changes in liabilities affect basis
    • Increase in share of partnership’s liabilities increases partner’s basis
    • Decrease in share of partnership’s liabilities decreases partner’s basis
    • Increase in partner’s individual liability increases partner’s basis
    • Decrease in partner’s individual liability decreases partner’s basis
partnership income loss
Partnership Income (Loss)
  • Partnership income and deductions must be segregated into ordinary and special items
  • Ordinary income and deductions include
    • Sales less COGS
    • Business expenses
    • Depreciation (not Sec. 179) and amort.
    • Sec. 1245, 1250, etc. recapture
    • Guaranteed payments to partners
partnership income loss10
Partnership Income (Loss)
  • Special items include
    • Capital gains and losses
    • Sec. 1231 gains and losses
    • Charitable contributions
    • Sec. 179 expense (ltd to $18,000 for 1997)
    • Interest, dividend and royalty income
    • Interest expense on investment indebt.
    • Net income or loss from rental real estate
    • Net income or loss from other rental
    • Foreign income taxes
partnership income or loss
Partnership Income or Loss
  • Character of gain or loss determined by nature of property in hands of partnership
  • Exception for contributed property:
    • Disposition of unrealized receivables is ordinary
    • Disposition of inventory within 5 years is ordinary
    • Capital asset disposed of at loss w/in 5 yrs is capital loss to extent of partner’s unrecognized loss (only applies to losses)
limitation of partnership loss
Limitation of Partnership Loss
  • Limited to partner’s basis
    • Loss is last item allocated to basis
    • Unused losses are carried forward
  • Limited to amount of “at risk” basis
    • Nonrecourse liabilities are not included unless from qualified real estate financing
  • If passive, limited to passive income
    • Includes non-material participation and rental activities
    • Limited partners fail material part.
    • Must own at least 10% for active part. in rental real estate for $25,000 exception
distributive share of income or loss
Distributive Share of Income or Loss
  • Special Allocations
    • must have substantial economic effect, not tax avoidance
  • Income(loss) related to contributed property
    • Precontribution gain must be allocated to contributing partner first
    • If distributed to different partner w/in 7 yrs. contrib. partner recognizes precontri gain
      • can avoid if like-kind distributed to contributing partner w/in 180 days or due date of tax return
distributive share of income or loss14
Distributive Share of Income or Loss
  • Change in ownership
    • Distributive shares of interest, taxes and payments for services or for use of property must be allocated by day
  • Income and guaranteed payments
    • Deemed to pass through on last day of partnership’s tax year
    • Not employee for fringe benefits
family partnerships
Family Partnerships
  • If primarily service business to be partner, family member must share in management or perform services
  • If capital is a material income producing factor , family member must own a capital interest
  • When interest is gifted and donor retains control over the partnership interest, the donor is taxed on the distributive share
transactions with controlled partnerships
Transactions with Controlled Partnerships
  • No losses are deductible from sales of property between a partnership and a person owning (directly or indirectly) more than 50% of the capital or profits interests in the partnership
    • Loss can be used to offset subsequent gain
  • If related person not owning directly or indirectly more than 50%, transaction is deemed between the related person and individual partners
  • Gain on sale between person owning more than 50% and partnership is not capital gain if property not capital asset in hands of partnership
partnership tax year
Partnership Tax Year
  • Earliest of following tests met:
    • Majority partner’s tax year (partners with same tax year owning >50%)
    • Principal partners’ tax year (all partners owning > 5% must have same tax year)
    • Least aggregate deferral rule
  • Can use different year if valid business purpose established & IRS permission
    • At least 25% gross receipts last 2 mos.
    • Satisfied for 3 consecutive years
least aggregate deferral
Least Aggregate Deferral
  • George owns 50% and has June 30 year end
  • Henry owns 50% and has October 31 year end
  • Neither partner owns a “majority” (>50%)
  • Both are “principal partners” (>5%), but do not have same year end
    • Must use least aggregate deferral test to determine required taxable year
least aggregate deferral example
Least Aggregate Deferral Example

1. Test June 30 as possible year end:

Partner.Year End%Mo. DeferralWeight

George June 50% 0 0.0

Henry October 50% 4 2.0

Total weighed deferral 2.0

2. Test October 31 as possible year end:

George June 50% 8 4.0

Henry October 50% 0 0.0

Total weighed deferral 4.0

June has the least aggregate deferral so it is the tax year for partnership.

tax year
Tax Year
  • Can elect fiscal year if deferral period < 3 months
    • Must make “required payment” (Deferred income x 40.6%)
  • Taxable year does not close with death, entry, sale or liquidation of partner’s interest
    • But partnership year ends with respect to partner whose entire interest is sold or liquidated
    • For years after 1997, partnership tax year closes with respect to deceased partner as of date of death
  • A partnership and its taxable year will terminate for all partners if a sale of 50% or more of total interests
sale of partnership interest
Sale of Partnership Interest
  • Generally, capital gain or loss
  • Exception: Gain is ordinary to extent attributable to:
    • unrealized receivables
      • includes recapture under 1245,1250,1252
    • appreciated inventory
      • includes all assets except capital and 1231
pro rata distributions from partnership
Pro Rata Distributions from Partnership
  • Partnership recognizes no gain or loss
  • If distribution of multiple items of property partner’s basis is reduced in this order:
    • Money
    • Unrealized receivables and inventory
    • Other property
  • Partner recognizes gain only to extent money exceeds the partner’s basis
    • Relief of liabilities is deemed money distribution
    • Gain is capital except attributable to unrealized receivables and substantially apprec. inventory
pro rata distributions from partnership23
Pro Rata Distributions from Partnership
    • If property other than money is received, gain is not recognized until disposition of property
  • Partner recognizes loss only upon complete liquidation through receipt of money, unrealized receivables or inventory
    • Loss is partner’s basis less money and partnership’s basis in unreal rec and inventory
    • Generally a capital loss
    • No loss can be recognized if other property is distributed
pro rata distributions from partnership24
Pro Rata Distributions from Partnership
  • Partner’s basis in property distributed
    • generally carryover basis
    • limited to partner’s outside basis less any money received
liquidating distribution pro rata
Liquidating Distribution Pro Rata
  • In general:
    • No gain or loss is recognized
    • Partner reduces basis in partnership interest by basis in property received at each level using Ordering Rules:

1. Cash, including relief of liabilities

2. Unrealized receivables and inventory

3. Other assets

    • Basis is allocated to assets within a category based on adjusted basis to partnership
    • Partner’s entire basis in interest will be absorbed by distributed assets
exception to liquidating distribution rules
Exception to Liquidating Distribution Rules
  • Gain is recognized if:
    • Cash exceeds partner’s basis
    • Precontribution gain exceptions
    • Disproportionate distribution
  • Loss is recognized only if:
    • Assets received include ONLY cash, unrealized receivables and inventory, and
    • Outside basis exceeds partnership’s inside basis in distributed property
liquidating distribution example
Liquidating distribution Example

Bill's basis in partnership interest: $30,000

Proportionate liquidating distributions (partnership also liquidates) ( independent fact situations):

G H I

Cash $50,000 $10,000 $10,000

Unrealized rec. N/A -0- -0-

(Fair mkt value) N/A $16,000 $16,000

Filing cabinet (1231) N/A N/A 300

(Fair mkt value) N/A N/A 300

liquidating distribution example28
Liquidating Distribution Example

G H I

Basis in interest $30,000 $30,000 $30,000

Cash distribution (50,000) (10,000) (10,000)

Gain recognized 20,000 N/A N/A

Basis after cash -0- 20,000 20,000

A/R distrib. N/A -0- -0-

Loss recognized N/A (20,000) N/A

Basis after A/R -0- -0- 20,000

Filing cabinet N/A N/A (20,000)

Ending basis $ -0- $ -0- $ -0-

liquidating distribution example29
Liquidating Distribution Example

G H I

Basis in p'ship int. $ -0- $ -0- $ -0-

Basis in cash 50,000 10,000 10,000

Basis in A/R N/A -0- -0-

Basis in filing cabinet N/A N/A 20,000

Capital (Gain)/loss (20,000) 20,000 N/A

Original basis $30,000 $30,000 $30,000