Chapter 21 Dispositions of Partnership Interests and Partnership Distributions

59. [LO 2, 3, 4] Simon is a 30% partner in the SBD partnership, a calendar-year-end entity. As of the end of this year, Simon has an outside basis in his interest in SBD of $188,000, which includes his share of the $60,000 of partnership liabilities. On December 31, SBD makes a proportionate distribution of the following assets to Simon:

Tax Basis FMV

Cash $ 40,000 $40,000

Inventory 55,000 65,000

Land 30,000 45,000

Totals $ 125,000 $150,000

a. What are the tax consequences (amount and character of recognized gain or loss, basis in distributed assets) of the distribution to Simon if the distribution is an operating distribution?

b. What are the tax consequences (amount and character of recognized gain or loss, basis in distributed assets) of the distribution to Simon if the distribution is a liquidating distribution?

c. Compare and contrast the results from parts a. and b.

60. [LO 1, 4] {Planning} Paolo is a 50% partner in the Capri partnership and has decided to terminate his partnership interest. Paolo is considering two options as potential exit strategies. The first is to sell his partnership interest to the two remaining 25% partners, Giuseppe and Isabella, for $105,000 cash and the assumption of Paolo’s share of Capri’s liabilities. Under this option, Giuseppe and Isabella would each pay $52,500 for half of Paolo’s interest. The second option is to have Capri liquidate his partnership interest with a proportionate distribution of the partnership assets. Paolo’s basis in his partnership interest is $110,000, including Paolo’s share of Capri’s liabilities. Capri reports the following balance sheet as of the termination date:

Assets: Tax Basis FMV

Cash $ 80,000 $ 80,000

Receivables 40,000 40,000

Inventory 50,000 80,000

Land 50,000 60,000

Totals $ 220,000 $ 260,000

Liabilities and capital:

Liabilities $ 50,000

Capital – Paolo 85,000

– Giuseppe 42,500

– Isabella 42,500

Totals $ 220,000

a. If Paolo sells his partnership interest to Giuseppe and Isabella for $105,000, what is the amount and character of Paolo’s recognized gain or loss?

b. Giuseppe and Isabella each have a basis in Capri of $55,000 before any purchase of Paolo’s interest. What are Giuseppe and Isabella’s basis in their partnership interests following the purchase of Paolo’s interest?

c. If Capri liquidates Paolo’s partnership interest with a proportionate distribution of the partnership assets ($25,000 deemed cash from debt relief, $15,000 of actual cash, andhalf of the remaining assets), what is the amount and character of Paolo’s recognized gain or loss?

d. If Capri liquidates Paolo’s interest, what is Paolo’s basis in the distributed assets?

e. Compare and contrast Paolo’s options for terminating his partnership interest. Assume that Paolo’s marginal tax rate is 35%, and his capital gains rate is 15 percent.

61. Carrie D’Lake, Reed A. Green, and Doug A. Divot share a passion for golf and decide to go into the golf club manufacturing business together. On January 2, 2014, D’Lake, Green, and Divot form the Slicenhook Partnership, a general partnership. Slicenhook’s main product will be a perimeter-weighted titanium driver with a patented graphite shaft. All three partners plan to actively participate in the business. The partners contribute the following property to form Slicenhook:

Partner Contribution

Carrie D’Lake Land, FMV $460,000

Basis $460,000, Mortgage $60,000

Reed A. Green $400,000

Doug A. Divot $400,000

Carrie had recently acquired the land with the idea that she would contribute it to the newly formed partnership. The partners agree to share in profits and losses equally. Slicenhook elects a calendar year end and the accrual method of accounting.

In addition, Slicenhook borrows $1,500,000 from BigBank at the time the contributions were made. Slicenhook uses the proceeds from the loan and the cash contributions to build a state-of-the-art manufacturing facility ($1,200,000), purchase equipment ($600,000), and produce inventory ($400,000). With the remaining cash, Slicenhook invests $45,000 in the stock of a privately owned graphite research company and retains $55,000 as working cash.

Slicenhook operates on a just-in-time inventory system so it sells all inventory and collects all sales immediately. That means that at the end of the year, Slicenhook does not carry any inventory or accounts receivable balances. During 2014, Slicenhook has the following operating results:

Sales $ 1,126,000
Cost of goods sold 400,000
Interest income from tax-exempt bonds 900
Qualified dividend income from stock 1,500
Operating expenses 126,000
Depreciation (tax)
§179 on equipment $39,000
Equipment 81,000
Building 24,000 144,000
Interest expense on debt 120,000

The partnership is very successful in its first year. The success allows Slicenhook to use excess cash from operations to purchase $15,000 of tax-exempt bonds (you can see the interest income already reflected in the operating results). The partnership also makes a principal payment on its loan in the amount of $300,000 and a distribution of $100,000 to each of the partners on December 31, 2014.

The partnership continues its success in 2015 with the following operating results:

Sales $ 1,200,000
Cost of goods sold 420,000
Interest income from tax-exempt bonds 900
Qualified dividend income from stock 1,500
Operating expenses 132,000
Depreciation (tax)
Equipment 147,000
Building 30,000 177,000
Interest expense on debt 96,000

The operating expenses include a $1,800 trucking fine that one of their drivers incurred for reckless driving and speeding and meals and entertainment expense of $6,000.

By the end of 2015, Reed has had a falling out with Carrie and Doug and has decided to leave the partnership. He has located a potential buyer for his partnership interest, Indie Ruff. Indie has agreed to purchase Reed’s interest in Slicenhook for $730,000 in cash and the assumption of Reed’s share of Slicenhook’s debt. Carrie and Doug, however, are not certain that admitting Indie to the partnership is such a good idea. They want at least to consider having Slicenhook liquidate Reed’s interest on January 1, 2016. As of January 1, 2016, Slicenhook has the following assets:

	Tax Basis	FMV
Cash	$ 876,800	$ 876,800
Investment - Tax Exempts	15,000	18,000
Investment Stock	45,000	45,000
Equipment - net of dep.	333,000	600,000
Building - net of dep.	1,146,000	1,440,000
Land	460,000	510,000
Total	$ 2,875,800	$ 3,489,800

Carrie and Doug propose that Slicenhook distribute the following to Reed in complete liquidation of his partnership interest:

	Tax Basis	FMV
Cash	$ 485,000	$ 485,000
Investment Stock	45,000	45,000
Equipment - net of dep.	111,000	200,000
Total	$ 641,000	$ 730,000

Slicenhook has not purchased or sold any equipment since its original purchase just after formation.

a. Determine each partner’s recognized gain or loss upon formation of Slicenhook.

b. What is each partner’s initial tax basis in Slicenhook on January 2, 2014?

c. Prepare Slicenhook’s opening tax basis balance sheet as of January 2, 2014.

d. Using the operating results, what are Slicenhook’s ordinary income and separately stated items for 2014 and 2015? What amount of Slicenhook’s income for each period would each of the partner’s receive?

e. Using the information provided, prepare Slicenhook’s page 1 and Schedule K to be included with its Form 1065 for 2014. Also, prepare a Schedule K-1 for Carrie.

f. What are Carrie’s, Reed’s, and Doug’s bases in their partnership interest at the end of 2014 and 2015?

g. If Reed sells his interest in Slicenhook to Indie Ruff, what is the amount and character of his recognized gain or loss? What is Indie’s basis in the partnership interest?

h. What is Indie’s inside basis in Slicenhook? What effect would a §754 election have on Indie’s inside basis?

i. If Slicenhook distributes the assets proposed by Carrie and Doug in complete liquidation of Reed’s partnership interest, what is the amount and character of Reed’s recognized gain or loss? What is Reed’s basis in the distributed assets?

j. Compare and contrast Reed’s options for terminating his partnership interest. Assume that Reed’s marginal tax rate is 35 percent, and his capital gains rate is 15 percent.