Apply Partnership Basis And Allocation Rules
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CPA Tax Compliance & Planning (TCP) › Apply Partnership Basis And Allocation Rules
A partner's outside basis in a partnership interest is initially determined by:
The fair market value of the interest received from the partnership.
The amount of cash contributed plus the adjusted basis of property contributed plus the partner's share of partnership liabilities assumed.
The partner's share of partnership book value at the time of acquisition.
The partner's proportionate share of the partnership's total assets.
Explanation
Outside basis = cash contributed + adjusted basis of contributed property + share of partnership liabilities assumed. Answer B is correct. Book value (A) is irrelevant to tax basis. FMV of interest received (C) would apply to purchased interests. Proportionate share of assets (D) is not the correct measure.
A partner contributes property with an adjusted basis of $30,000 and a fair market value of $50,000 to a partnership. Under Section 721, the contribution results in:
The partnership taking a fair market value basis of $50,000 in the property.
The partner recognizing a $20,000 gain on the contribution.
The partner recognizing a $20,000 gain and the partnership taking a $50,000 basis.
No gain or loss recognized by either the partner or the partnership - the partnership takes a carryover basis of $30,000 in the property and the partner's outside basis reflects the $30,000 contributed basis.
Explanation
Section 721 provides nonrecognition for property contributions to partnerships. The partnership takes a carryover basis (the partner's $30,000 adjusted basis) and the partner's outside basis reflects the contributed property's basis. Answer A is correct. No gain is recognized (B, D). The partnership does not step up to FMV (C, D).
A partner has an outside basis of $10,000. The partnership allocates $15,000 of losses to the partner. How much of the loss may the partner deduct, and what happens to the remaining loss?
$10,000 is deductible and the remaining $5,000 carries forward, but the partner must restore basis before deducting the carryforward.
$10,000 is deductible (limited to basis); the remaining $5,000 is suspended and carries forward indefinitely until the partner has sufficient basis to absorb it.
The full $15,000 is deductible; the partner's basis goes to negative $5,000.
$10,000 is deductible; the remaining $5,000 is permanently lost.
Explanation
Partner losses are limited to outside basis - the $10,000 basis limits the deductible loss to $10,000 with basis going to zero. The suspended $5,000 carries forward until basis is restored. Answer D is correct. Basis cannot go negative (A). Suspended losses are not lost permanently (B). The carryforward in C is correct but doesn't require basis restoration before deducting (D is more accurate).
A partnership has recourse liabilities of $60,000. A partner bears the economic risk of loss for $20,000 of those liabilities. How much do the recourse liabilities increase the partner's outside basis?
$60,000 - the partner's share of all partnership liabilities.
$30,000 - 50% of the recourse liabilities under the equal allocation rule.
$20,000 - the amount of recourse liability for which the partner bears the economic risk of loss.
$0 - recourse liabilities do not affect outside basis.
Explanation
Recourse liabilities are allocated to partners based on who bears the economic risk of loss for those liabilities. The partner's basis increases by $20,000 - their share of the recourse debt. Answer B is correct. Basis is not increased by liabilities beyond the partner's risk (A). Recourse liabilities do affect basis (C). Equal allocation (D) applies only if no partner bears risk of loss.
Under Section 704(b), a partnership allocation must have 'substantial economic effect' to be respected for tax purposes. Which of the following is a key requirement of substantial economic effect?
Allocations must follow the partners' ownership percentages.
All allocations must be approved by the IRS before the partnership files its return.
The allocation must result in at least one partner having an increased tax liability.
Allocations must be reflected in the partners' capital accounts maintained under the economic effect rules, and upon liquidation, partners must receive distributions in accordance with positive capital account balances.
Explanation
Substantial economic effect requires: proper capital account maintenance, liquidation in accordance with capital accounts, and deficit restoration obligation (or qualified income offset). Answer C is correct. Allocations need not match ownership percentages (A). IRS pre-approval is not required (B). Increased tax liability is not the test (D).
A partner receives a guaranteed payment from the partnership. The tax treatment of guaranteed payments is:
Included in the partner's gross income as ordinary income and deductible by the partnership as a business expense - treated similarly to wages but the recipient partner is subject to self-employment tax.
Deductible by the partnership and excluded from the partner's income.
Excluded from the partner's gross income as a partnership distribution.
Treated as a return of capital, reducing the partner's outside basis.
Explanation
Guaranteed payments are treated as ordinary income to the recipient partner and are deductible by the partnership - similar to wages but paid regardless of partnership income. Answer D is correct. They are not return of capital (A). They are included in income (B). They are both deductible by partnership and included in partner income (C).
A Section 754 election allows a partnership to:
Adjust the inside basis of partnership assets when a partnership interest is sold or transferred, or upon a distribution that would otherwise trigger a basis discrepancy - aligning inside basis with the transferee's outside basis.
Elect out of partnership taxation and be treated as a corporation.
Retroactively change the partnership's accounting method.
Eliminate built-in gain on contributed property at the partnership level.
Explanation
A Section 754 election allows optional basis adjustments under Section 734(b) (distributions) and 743(b) (transfers) to eliminate disparities between inside and outside basis. Answer A is correct. It is not an entity classification election (B). It does not change accounting methods (C). Built-in gain from contributions is addressed under Section 704(c), not 754 (D).
Under Section 704(c), when a partner contributes property with a built-in gain or loss to a partnership, the tax consequences are:
The built-in gain or loss is allocated proportionately to all partners based on profit interests.
The built-in gain or loss is recognized by the partnership immediately upon contribution.
The built-in gain or loss must be allocated back to the contributing partner when the property is later sold or depreciated, to prevent shifting of pre-contribution gain or loss to other partners.
The contributing partner's outside basis is adjusted to the fair market value of the contributed property.
Explanation
Section 704(c) prevents the shifting of built-in gains or losses to non-contributing partners by requiring that pre-contribution gain/loss be allocated back to the contributing partner on disposition. Answer C is correct. No immediate recognition (A). Pre-contribution G/L is not allocated proportionately (B). Outside basis is the contributed property's adjusted basis, not FMV (D).
A limited partner in a limited partnership may deduct partnership losses only to the extent of:
The partner's outside basis in the partnership interest - losses in excess of outside basis are suspended until the partner has sufficient basis.
The partner's share of partnership taxable income from other partnerships.
The partner's capital account balance.
The fair market value of the partner's interest in the partnership.
Explanation
All partners (limited and general) are limited in loss deductions to their outside basis. Limited partners face additional restrictions (at-risk and passive activity rules), but the basis limitation is the threshold test. Answer D is correct. Other partnership income (A) relates to the passive activity rules, not the basis limitation. FMV (B) and capital accounts (C) are not the basis limitation standard.
Which of the following best describes the 'ceiling rule' under Section 704(c)?
The rule that caps guaranteed payments at the partner's capital account balance.
The rule that limits a partner's outside basis to the fair market value of their partnership interest.
The rule that limits partnership allocations to no more than the partnership's total income.
The rule that limits the amount of 704(c) tax allocations to the total depreciation or gain available at the partnership level - preventing non-contributing partners from receiving less than their book share of deductions.
Explanation
The ceiling rule limits Section 704(c) allocations to the partnership's actual tax items available - if tax depreciation is less than book depreciation, the ceiling rule prevents non-contributing partners from getting their full book allocation. Answer C is correct. Total income limitation (A) is not the ceiling rule. Outside basis limitation (B) is a different rule. Guaranteed payment caps (D) are unrelated.