Study Material for First Research Case - Tax of Pass Through Entities | ACCT 6130, Study notes of Accounting

Download Study Material for First Research Case - Tax of Pass Through Entities | ACCT 6130 and more Study notes Accounting in PDF only on Docsity! ACCT 6130 First Research Case Fall 2008 Dr. Burton 1. A and B are partners in an equal general partnership. A has a basis of $30,000 in his partnership interest. B has a basis of $10,000 in her partnership interest. What is the effect of each of the following events on the basis of each partner’s partnership interest? When is the effect taken into account? a. The partner ship makes a charitable contribution of $5,000. Under Section 703(a), the taxable income of a partnership is determined as if the partnership were an individual, with certain exceptions. Section 703(a) (2) (C) contains such an exception for charitable contributions which are not deductible by the partnership but must be separately stated. IRC Section 702(a) (4). The basis of partnership interests are decreased by expenditures which are not deductible in computing partnership taxable income. IRC Section 705(a)(2)(B). If the basis were not decreased by the expenditure, a potential loss would be created where one should not exist, because the fair market value of the partnership interest would decrease when the expenditure was made. b. Each partner’s distributive share of partnership taxable income is $10,000. Basis of each partner’s interest is increased by $10,000 as of the last day of the partnership’s taxable year in order to prevent double taxation upon a subsequent sale. IRC Section 705(a)(1)(A); Reg. Section 1.705-1(a). c. The partnership has $8,000 in interest income from tax-exempt municipal bonds. Basis of each partner’s interest in the partnership is increased by $4,000 (Section 705(a)(1)(B)) in order to prevent the exempt interest from being converted to taxable income upon a subsequent sale of the partnership interest at a value which reflects that interest as an asset. This treatment assures that the tax exempt character of the income is preserved. d. The partnership makes a cash distribution of $10,000 to each partner. A cash distribution to a partner decreases the basis (but not below zero) of his partnership interest by the amount of the cash, here $10,000 each (Sections 733 and 705(a)(2)), at year end if the distribution is an advance or draw against the partner’s distributive share of income for the year. Reg. 1.731-1(a)(1)(ii). e. The partnership exchanged rental real estate with a fair market value of $100,000 and an adjusted basis of $30,000 for other real estate worth $100,000 in a Section 1031 exchange. No basis adjustment is permissible. Although the partnership has realized gain of $70,000, the gain is not recognized. IRC Section 1031. The tax on the gain merely is deferred and, therefore, basis should not be increased. Obviously, recognition of gain would result in an increased basis. Support for the position that no basis adjustment is available comes from Section 705(a)(1)(A) which focuses on taxable income, a term which does not include unrecognized gains. Furthermore, Section 7105(a)(1)(B) addresses exempt income, and unrecognized income under Section 1031 is deferred income. f. The partnership received $5,000 for granting an option on a building it owns, which is worth $1 million. There should be no basis adjustment for the partners’ partnership interests. Inclusion of an option payment in gross income is only deferred, not exempt. The inclusion of the option payment in income occurs upon the lapse or the exercise of the option. (However, an inequality now will exist between the inside basis (total assets) and outside basis (total basis of partnership interests), because outside basis does not reflect the receipt of cash for the option. g. During the year, a lease was terminated. The partnership’s lessee expended $30,000 in improvements which were not substitutes for rent during the lease period. The fair market value of the improvements was $50,000 on the date the partnership took possession of the leased premises. Most likely there is no basis adjustment. Technically, Section 109 is an exclusion section. However, in reality it operates generally more as a tax-deferral provision, excluding from the income of a lessor upon termination of a lease any income derived in the form of improvements made by the leasee. The leassor will take the improvements into account when the property is sold and the value at that time is realized. IRC Section 1019. To allow an increase to the basis of the partnership interest would mean that the partner would never recognize gain if he sold his interest, contrary to the theory of a deferral. However, the gain potential would remain at the partnership level should it dispose of the asset. h. The partnership paid $2,000 in life insurance premiums to insure the lives of key employees, with the partnership named as beneficiary. The basis of each partnership interest is decreased by $1,000. IRC Section 705(a)(2)(B). Life insurance premiums are not deductible by the partnership if the partnership is directly or indirectly a beneficiary. IRC Section 264(a)(1).