CPA Regulation (REG) : Realized & Recognized Gains in Formation/Liquidation

Study concepts, example questions & explanations for CPA Regulation (REG)

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Example Questions

Example Question #1 : Taxation Of Flow Through Entities

Anne and Bart formed AB, LLC, a limited liability company, and elected to treat it as a partnership for tax purposes. Anne contributed $10,000 cash, and Bart contributed $5,000 cash, but Bart had a special skill that the partnership needed to be successful. The partnership agreement stated that Anne and Bart would both have a 50% interest in the LLC and that all profits and losses would be divided evenly between them. The LLC paid Bart $5,000 in year 1 for Bart's services to the partnership. The $5,000 would generally be reported to Bart as which of the following?

Possible Answers:

A guaranteed payment.

Wages.

Dividends.

Salary.

Correct answer:

A guaranteed payment.

Explanation:

When a capital interest is acquired for services provided to a partnership, the interest is treated as ordinary income to the partner. Ordinary income to a partner is classified as guaranteed payments.

Example Question #2 : Taxation Of Flow Through Entities

A partner sold a 25% interest in a partnership for $400,000 cash plus assumption of the partner's share of the partnership liabilities. The following additional information relates to the partnership activities:

  • Partner's initial cash contribution: $ 100,000
  • Partnership income during the partner's ownership time period: 1,000,000
  • Partnership liabilities at date of sale: 60,000
  • Partner's cash withdrawals: 50,000

How much gain is recognized by the partner upon the sale of the partnership interest?

Possible Answers:

$650,000

$35,000

$50,000

$100,000

Correct answer:

$100,000

Explanation:

To determine the gain on the sale of the interest, the partner’s basis in the interest must first be determined:

  • Initial Contribution: $100,000
  • 25% Partnership Income over Period of Ownership: $250,000
  • 25% Share of Partnership Liabilities: $15,000
  • Partner’s Cash Withdrawals: $(50,000)
  • Total Partnership Basis: $315,000

Example Question #3 : Taxation Of Flow Through Entities

Taryn, Rose, and Summer are equal partners in TRS partnership. Taryn contributed land with an adjusted basis of $20,000 and a fair market value (FMV) of $50,000. Rose contributed equipment with an adjusted basis of $40,000 and an FMV of $50,000. Summer provided services worth $50,000. What amount of income is recognized as a result of the transfers?

Possible Answers:

$150,000

$60,000

$90,000

$50,000

Correct answer:

$50,000

Explanation:

In formation of a partnership, the only two instances in which a gain (income) is recognized is when a partner contributes services in exchange for capital interest, or when property contributed is subject to a liability in excess of the property’s adjusted basis. Here, Summer provided services and so would recognize $50,000 of income. The other two partners would recognize no gain on their contribution of property.

Example Question #4 : Taxation Of Flow Through Entities

In the absence of an election to adopt an annual accounting period, the required tax year for a partnership is:

Possible Answers:

A tax year of one or more partners with a more than 50% interest in profits and capital

A tax year of a principal partner having a 10% or greater interest

A calendar year

A tax year that results in the greatest aggregate deferral of income

Correct answer:

A tax year of one or more partners with a more than 50% interest in profits and capital

Explanation:

In the absence of election to adopt an annual accounting period, the required tax year for a partnership is the tax year of one or more partners who have more than 50% interest in aggregate of profits and capital, per the majority interest rule

Example Question #5 : Taxation Of Flow Through Entities

Andrew contributed the following assets to a partnership in exchange for a 50% interest in the partnership’s capital and profits: Cash of $50,000, Equipment with a FMV of $35,000 and Carrying amount of $25,000. Andrew’s basis in the partnership is:

Possible Answers:

$75,000

$42,500

$85,000

$37,500

Correct answer:

$85,000

Explanation:

The basis of the partner’s interest in the partnership is calculated as $50,000 + $25,000 = $75,000.

Example Question #6 : Taxation Of Flow Through Entities

A partner’s basis in a partnership will increase by his or her share of liabilities assumed by the partnership.

Possible Answers:

False

False if the partnership was formed before 2017

True if the partnership was formed before 2017

True

Correct answer:

True

Explanation:

This statement is true and has no correlation with the TCJA or any other tax reform.

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