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Discussion:Partnership contribution, built in gains and K-1

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Discussion Forum Index --> Advanced Tax Questions --> Partnership contribution, built in gains and K-1


Discussion Forum Index --> Tax Questions --> Partnership contribution, built in gains and K-1

Taxmonkey (talk|edits) said:

27 March 2014
A and B are forming a partnership. B acquires 10% interest in A's property at the current FMV. A and B then contribute the property to the new partnership. A has owned the property for many years and his adjusted basis is less than FMV. Lets say FMV is $300,000, and his adjusted basis is $100,000. After B acquires 10%, A will recognize gain of $20,000 ($30k - $10k basis) and will contribute the remaining property with a built in gain of $180k ($270k - $90k basis).

A will have a book capital account at $270K and a tax capital account at $90k, B will have book and tax at $30k

If I understand 704(c) properly the depreciation on the property will be allocated to B until A's book value and adjusted basis are equal. I really just want to confirm that I should make an actual adjustment to the K-1s to change the partners share of losses to reflect this allocation. In other words increase B's loss, by including A's portion of depreciation?

in a few years, this allocation will make B's capital account negative. At that point 704(d) would cause the losses to be suspended.

I guess I am just nervous actually manually adjusting the K-1s, and I am not sure what method of reporting the partner's capital accounts on the K-1 (tax or 704(b) book) would be more useful. Any thoughts appreciated.

Ckenefick (talk|edits) said:

27 March 2014
in a few years, this allocation will make B's capital account negative.

How's that? You don't move all of the tax depreciation over from A to B each year, just "up to" the amount of B's annual book depreciation allowance.

Ckenefick (talk|edits) said:

27 March 2014
I really just want to confirm that I should make an actual adjustment to the K-1s to change the partners share of losses to reflect this allocation. In other words increase B's loss, by including A's portion of depreciation?

Once you get things straightened out, based on my comment above, then yes, you definitely adjust the tax numbers on the K1's.

Let's pretend this is 5-year property and all is depreciable. Annual book depr is $60,000 [$300,000 book basis divided by 5-years]. A gets 90% of this, or $54,000. B gets 10% of this, or $6,000.

Annual tax depr is $24,000 [$120,000 tax basis divided by 5-years]. Initially, A gets 90% of this, or $21,600. Initially, B gets 10% of this, or $2,400.

B gets screwed b/c he contributed post-tax dollars, his book basis capital account is charged for $6,000 of annual book depreciation, yet he's only getting $2,400 of tax depreciation. So, we move $3,600 of A's tax depr over to B, to bring B's tax depr allocation up to the full $6,000. So, we can fully cure B's problem each year. B's annual book and tax depreciation will both equal $6,000. At the end of 5-years, assuming break even operations over this period, B's tax basis capital account will be $0, it won't be negative. And B's book capital account will also be $0.

$30k - ($6k x 5-years) = $0.

Doug M (talk|edits) said:

27 March 2014
Or, since this partnership is just forming, think about allocating tax depn deductions according to the basis of the property contributed. (which would be the tax capital account basis)

Taxmonkey (talk|edits) said:

27 March 2014
Thank you ! I had neglected to cap the adjustment at B's book depreciation amount and therefore was giving him far too large of an adjustment.

Ckenefick (talk|edits) said:

27 March 2014
http://www.aicpa.org/Publications/TaxAdviser/2014/february/Pages/Greenwell_Feb2014.aspx?action=print

Read this and have a full report on our desk in the morning.

Thank you ! I had neglected to cap the adjustment at B's book depreciation amount and therefore was giving him far too large of an adjustment.

Exactly, now you've pissed Mr. A off.

Also, do note that 704(c) is mandatory.

Ckenefick (talk|edits) said:

27 March 2014
You also gotta think a little theory here...A put a lot of pre-tax dollars into this deal - $180k worth. His unrealized appreciation.

If this was land, we'd have no choice but to do all the curing @ disposition. We couldn't even use remedials (since there are no book/tax allocation differences with respect to the contributed property). As such, we'd have a disproportionate allocation of tax gain to A entirely on the back end. On the back end, the book value of the property would still be $300k...and if sold for exactly $300k, guess what: ALL $180k of the tax gain gets allocated to A. B didn't have a gain. He put in $30k for 10% and he gets $30k back out.

But when the property is depreciable, 704(c) steps in and says: You can't wait until disposition to cure. You gotta cure as you go. And reducing A's deductions, with respect to the contributed property, as we go, is consistent with allocating more gain to A on the back end. Mr. A might not like it, but that's the way it goes. A contributed a lot of pre-tax property dollars and he shouldn't be able to get a tax depreciation deduction because of it.

In OP's case, if property is held until it depreciates down to $0 for book and tax (must be depreciated at the "same rate") all the curing will have happened. Everyone's book and tax capital accounts will be $0. Property's book basis will be $0. If sold for $0, everyone walks away already having been zeroed out. If prop sells for $100k, A gets $90k of tax gain and a $90k distribution. B gets a $10k tax gain and a $10k distribution.

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