Tax Accounting Principles: Corporate and Partnership Transactions
Exam 1:
(Extensions → 6 months for everyone)
Chapter 2: Statute of Limitations–
1. Normal → 3 years from later of original due date or date filled 2. Omission of > 25% of gross income → 6 years 3. Fraud and/or failure to file → indefinite Trial courts and where appeals go–
1. Must go through the process (Revenue Agent’s Report (RAR), 30-day letter, informal appeal, and 90-day letter) before going to court 2. The tax deficiency must be paid prior to filing in the Court of Federal Claims or a District Court (then taxpayer sues for a refund) 3. Prior payment is NOT necessary in the Tax Court (If tax is due in court, interest must be paid by the taxpayer) 4. The Small Claims Court is for $50,000 or less and is fully binding (you can’t appeal)
Golsen Rule
The Tax Court must follow a decision of the Court of Appeals of jurisdiction and a decision can be different if there’s identical court cases, but are in different jurisdictions (ex: Same case where A lives in Texas, 5th circuit court of appeals rule in favor on this issue in the past, tax court must follow the decision, but B lives in New York, 2nd circuit court of appeals hasn’t heard this issue before, so the tax court render against B)
Primary vs. Secondary
Sources of Law–
Primary comes from legislative, administrative, or judicial sources (ex: Internal Revenue Code) and Secondary is when someone interprets the law, can’t site it or use it as an authority (ex: Tax Article in USA Today)
Chapter 16: Converting Book Income into Taxable Income–
1. Book Income +/- BTDs = Taxable Income 2.
Favorable → Lower TI to Book (Subtract from Book Income) & Unfavorable → Higher TI to Book (Add back to Book Income) 3.
Temporary Differences (Reverses Favorable and Unfavorable adj.) (Deductible) – Depreciation/Amortization, Gain or Loss on dep./amort.
property, Warranty Expense, BDE, Unearned Revenue, Deferred Compensation Expense, Contingent Liabilities (e.G., Litigation), Organizational Expenditures, NOL, Charitable Contributions (if limited), & Net Capital Loss Permanent Differences (Non-Deductible) – Tax-exempt Interest Income, Expenses related to TE Income, Life Insurance Proceeds (includes inc. In Cash Surrender Value), Life Insurance Premiums, Fines & Penalties, Political Contributions, Meal (50% ded.)/Entertainment Expenses, Dividends Received Deduction, Federal Income Tax Expense, Charitable Contributions (if haircut) (CTE = (Pre-Tax Book Income – Total BTDs) x 21%)
Chapter 17:
Total Tax Expense = Current + Deferred Tax Expense 7 Steps to Accounting for Income Taxes–
Step 1–
Adjust Pre-Tax Book Income (PTBI) for Permanent BTDs ETR = Total Tax Expense / Pre-Tax Book Income (only permanent BTDs affect ETR)
“Book Equivalent of Taxable Income” (BETI)
= Pre-Tax Book Income – Permanent BTDs Total Tax Expense = BETI x 21% (= CTE + DTE)
Step 2
Identify All Temporary BTDs, including Tax Carryforwards Deductible Temporary BTD → DTA that is currently Unfavorable (Future Deductible Amount) (ALL Carryovers are DTAs)
Taxable Temporary BTD → DTL that is currently Favorable (Future Taxable Amount)
Step 3
Compute Current Income Tax Expense/(Benefit)
Current Tax Expense = Taxable Income x 21% (= (Pre-Tax Book Income – Total BTDs) x 21%)
Step 4
Determine Ending Balances of DTAs and DTLs (Tax less Book Basis)
JE → Dr. DTE or DTA Cr. DTL or DTB (100% Bonus Depreciation for Tax Purp., Bad Debts are a Contra-Asset → DTA, & Deduct once paid for Cont. Liab.)
Step 5
Determining whether a VAA is needed Offset DTAs with a valuation allowance (Contra-Asset) if it’s “more likely than not” (i.E., > 50%) that some portion of the DTAs will NOT be realized (It’s about the realizability of Future Tax Benefits – DTAs) (Based the weight of all Positive (e.G., DTLs future reversals) and Negative (e.G., History of NOLs) Evidence)
JE → Dr. DTE Cr. VAA Step 6–
Calculate Deferred Income Tax Expense/(Benefit) (Total DTAs less VAA less Total DTLs)
JE → Dr. DTA Cr. DTL & Dr. DTE or Cr. DTB Step 7–
Account for Uncertain Tax Positions aka “Tax Reserve” (Those that might get reversed upon audit) (2-step process)
1. Determine if it’s “more likely than not” (i.E., > 50%) that the tax position will be sustained upon audit (If failed, then it’s a full reserve for that position)
2. Recognize largest benefit where the cumulative probability exceeds 50% Tax Benefit NOT recognized → JE = Dr. CTE Cr. Income Taxes Payable (ITP) (A Decrease in Tax Reserves → Dr. CTE Cr. ITP)
Exam 2:
(E&P (uses Tax Law)
Theoretically represents a firm’s Economic Income) (CEP ~ Net Income & AEP ~ Beginning Balance in Retained Earnings) (Recognized Gain/Loss on Property Distribution = FMV – Adjusted Basis) (351 applies during corporate formation & future exchange of property for stock) (IRC§351(a) postpones gain/loss until the S/H disposes the stock)
Chapter 18: Computation of CEP–
Taxable Income PLUS
Tax-exempt municipal bonds interest income, Life Insurance Proceeds, DRD, NOL Carryforwards, Net Capital Loss Carryforwards, Charitable Contribution Carryforwards MINUS
Nondeductible portion of M&E expense (50%;100%), Related-Party Losses, Expenses incurred to produce Tax-Exempt Income, Federal Income Taxes paid, Nondeductible key employee Life Insurance Premiums (Plus – Net inc. In Cash Surrender Value), Nondeductible Fines & Penalties, Lobbying Expenses, Current year Net Capital Loss TIME ADJ.
(shift from year of Ded. (+) to year of Economic Effect (-)) Immediate Gain Recognition, Straight-Line ADS Dep., Gain or Loss on sale of depreciable assets due to lower asset basis for TI vs. E&P purposes (Subtract Greater Gain, Lesser Taxable Loss), LIFO recapture amount (= Excess of FIFO over LIFO) (IRC §179 Expense Deductions & Amortization of Organizational Expenditures are NOT allowed)
Corporate Distributions
1. E&P → Taxed as Dividend Income 2. Stock Basis → Nontaxable Return of Capital 3. Distribution in Excess of E&P & Basis → Taxed as Capital Gain Cash Distributions–
1. Negative CEP & Negative AEP
NO E&P, so either Return of Capital or Capital Gain 2. Positive CEP & Positive AEP–
Reduce CEP first, then AEP then Stock Basis. If there are multiple distributions & the Total Distributed > CEP → Allocate CEP on a “pro rata basis”, allocate each distribution = CEP x (Amount of Individual Distribution / Amount of Total Distributions). AEP gets the allocated remainder in Chronological Order 3. Positive CEP & Negative AEP–
Taxable Dividend to the extent of Positive CEP then Stock Basis 4. Negative CEP & Positive AEP–
Take the Loss (CEP) & pro rata it to the date of distribution (e.G., CEP = (20,000) Distribution is on July 1st → (20,000) x 1/2) then Net CEP & AEP as of the date of the distribution. If Positive, it’s a dividend to the extent of the Positive Balance, else use Stock Basis Noncash (Property) Distributions–
1. Recognize Gain on the distribution of appreciated property, but don’t Recognize a Loss on depreciated property (NOT Recognized for Tax or CEP purposes) If the distributed property is subject to a Liability > FMV, then use the Liability amount as the FMV 2. Effect on E&P–
Gain Recognized on appreciated property increases E&P & property distributions reduce E&P by the greater of FMV or E&P Basis less any Liability associated to the property then Net the E&P gain & loss effect (Only Losses (NOT Distributions) can generate/add to deficits in E&P)
Stock Distributions (Stock Dividends)
1. Proportionate Distribution
Nontaxable & does NOT reduce E&P (Distributed is ‘identical’ to Original Stock unless stated otherwise, Holding period of the New Shares = Holding period of the Originally held stock) Tax Basis is reallocated to all the shares now owned (Original & New). If ‘identical’–
New Per Share Basis = Original Basis / Total # Shares Now Owned. If NOT ‘identical’–
Allocate Tax Basis based on relative FMVs = [FMV of Original / Total FMV] x Original Basis & [FMV of New / Total FMV] x Original Basis 2. Disproportionate Distribution–
Taxable & reduce E&P (by FMV) (Holding Period of the New Shares starts on the date of receipt) Tax Basis = New Shares FMV Stock Redemptions–
1. Qualifying
Treated as Sales of property (Capital Gain/Loss) Recognizes Capital Gain = Cash + FMV of property received – Stock Basis (Related S/Hs > 50% ownership
CANNOT recognize Losses on Qualifying Redemptions)
2. Non-Qualifying
Treated as Dividend Distributions (Dividend Income) Recognizes Dividend Income = Cash + FMV of property received 3. Stock Attribution Rules (Applies, then Non-Qualified) –
Related Parties: spouse, children, grandchildren, parents, partnerships, estate, trusts, and corporations – when S/H owns 50% or more of the corporation 4. Substantially Disproportionate (Applies, then Qualified)–
S/H after the distribution owns < 50% & their % ownership before the redemption is < 80% Example: Ryan, Dan, & Brian (unrelated) own 30, 30, & 40 shares. The company has E&P of $1million and redeems 20 shares of Brian’s stock for 60k. Brian paid $100 per share years ago.
50% Test:
50% > (40-20) shares after / (100-20) total shares after = 25% √ 80% Test:
80% x 40% own before = 32% > 25% (from 50% Test) √ Sale Treatment:
LTCG = FMV – basis = 60k – (100 x 20 shares) = 58k E&P Reduction Lesser of:
1. 20 redeem / 100 total = 20% x $1million = 200k vs. FMV Distribution = 60k, so E&P after = $1million – 60k = 940k
Chapter 19:
IRC §351 Mandatory Nontaxable transfers to a Corporation – Three-pronged test
1. Property is transferred (Any ‘services rendered’ is ordinary income)
2. In exchange for Stock, and (Includes Common & Preferred Stock, NOT Nonqualified Preferred Stock, Stock Rights, or Stock Warrants) (Debt & other Non-Equity Securities received are treated as “Boot”) 3. Property transferors are in Control of the corporation after the exchange (Occurs after the exchange when a person transfers property has >= 80% stock ownership & >= 80% of the total # of shares of all other classes) (“Control Test” can apply to a single or to several taxpayers if they’re in an “integrated transaction”, the details of the transfer must be previously determined & executed with “orderly procedure”)
1. Recognized Gain Only from Stock:
= FMV of property received – Tax Basis transferred 2. Recognized Gain from “Boot Received”:
(when Taxpayer receives cash/property other than stock) = The lesser of Realized Gain or Boot Received 3. Realized Gain:
= FMV of property received (including Boot) + Liabilities from the transferor(S/H) – Tax Basis of property transferred – FMV of Boot paid – Liabilities assumed by the transferor 4. Basis of Stock to Shareholder:
= Substitute basis + gain recognized on the exchange – boot received (including liabilities from the transferor)
5. Basis of Property to Corporation:
= Carryover basis + gain recognized by transferor Aggregate Built-in Losses without Election:–
When aggregate basis of assets transferred > their FMV, allocate proportionately [(Built-in Loss #1) / (Total Built-in Losses)] x (Net Built-in Losses) then Subtract it by its Tax Basis (If gain/stock, basis remains the same)
Aggregate Built-in Losses with Election (from S/H & Corporation):
Reduce instead the S/H’s stock basis Stock Basis = Substitute Basis – Net Built-in Losses (Asset Basis remains the same)
IRC §357 For Corporations assuming/taking a Liability:
1. General Rule – Its NOT a Boot for gain recognition purposes (Still need to account for other boot received) 2. If Liabilities transferred > AB – Gain recognized is the Excess (Taxpayer stock basis is Always = 0) 3. Tainted Liabilities – ALL liabilities are Boot (Treat it like you’re receiving the Boot!)
IRC §1244 Small Business Stock: First owners of “small” corporations where the Basis (NOT FMV) < $1million – If the Stock is sold at a Loss → Ordinary Loss Deduction up to $50k for Single & $100k for MFJ; remainder is Capital (Gain on sale of Stock remains Capital) (Total Gain/Loss on Sale = Amount of Stock Sold – Property Transferred Basis)
Complete Liquidations:
Taxable Sale or Exchange to the S/H & Corporation (Capital Gain/Loss) 1. S/H Potential Tax Consequences → FMV received – Basis in Stock 2. Corporation Potential Tax Consequences → FMV Distributed – Basis in Property (If the distributed property is subject to a Liability > FMV, then use the Liability amount as the FMV)
Complete Liquidation “Anti Stuffing” Limitations for Corporate Losses: 1. Related-Party Loss Limitation–
Losses are Disallowed on Distributions to Related Parties (including Siblings) if either: The Distribution is NOT Pro Rata OR The Property distributed is a Disqualified Property (Acquired by Corporation in a 351 transaction or as a Contribution to Capital, during a 5-year period ending on the Date of Distribution)
2. Built-in Loss Limitation
Disallows Losses from the Sale, Exchange, or Distribution to ANY S/H (related or unrelated) shortly before its liquidated & it applies when both: Property was acquired in a 351 or as a Contribution of Capital transaction AND the Principal Purpose of acquisition was to recognize the Built-in Loss (Disallowed loss limited to the Built-in Loss)
Complete Liquidation of a Subsidiary:
Parent Corporation does NOT recognize gain/loss on the Liquidation of a Subsidiary (own >= 80% of voting and the total value of all stock) Subsidiary does NOT recognize gain/loss on the Distribution of property to its Parent (must distribute all property within the Tax Year of Stock Cancellation OR within 3 years of the close of the Tax Year – and must be Solvent)
Complete Liquidation of a Minority S/H:
Liquidating Corporations recognize gains (but NOT Losses)
on the Distribution to Minority S/Hs 1. Minority S/H Gain/(Loss) = FMV of Assets Received – Basis in Stock
Chapter 20:
IRC §721 Partnership Formation
– Two-pronged test
1. Partners contribute Property to a Partnership 2. In exchange for a Partnership Interest and defer gain/loss on the transaction (If Cash Received > Adj. Basis given up, then Recognized Gain = Excess)
1.
IRC §721 Assumption of Liabilities:
1. If the Partnership assumes a Liability from a Partner, that Partner does NOT recognize a gain 2. The Contributing Partner’s Basis First is reduced by the Total Amount of Liabilities and Second is increased by the Amount of Liabilities allocated to that Partner
2
When IRC §721 Does Not Apply:
1. Contributions of Services – If the Partner receives Capital → Tax on the FMV & if the Partner receives a Profits Interest → NOT Taxed 2. Taxable Exchanges of Properties (Giving the Property instead to the other Partner in an exchange) 3. Disguised Sales of Properties (e.G., Thought it was Property but it was actually Cash)
IRC §704 Pre-Contribution Gain/Loss:
When a Partnership disposes Property in a IRC 721 transaction 1. Gain/Loss is allocated to Contributing Partner (Applies to Property Contributed <= 7 years before date of sale) 2. Post-Contribution Gains/Losses allocated using Profit/Loss sharing ratios) (Partnership’s Basis in Loss Property = FMV on the date of Contribution) Example: Nick & Jean share 50% in the Partnership, Contributed 100k Cash (Jean) & 100k FMV Basis 50k Land (Nick)(BIG = 50k), Sell Land for 110k → Total Gain = 110k – 50k (Basis) = 60k Gain → Pre-Contribution = 50k ALL to Nick (His BIG) → Post-Contribution (60k – 50k) = 10k Nick(50%) = 5k & Jean(50%) = 5k → Nick’s Total Gain = 50k + 5k & Jean’s Total Gain = 5k
Chapter 20 (Continued):
1. Character of Gain/Loss:
(No Beneficial conversions of Character of Built-in Gains/Losses) 1. Built-in Capital Losses & Ordinary Gains → “Original Character” Rule – BIG/BIL retains its Original Character & how the Partnership used the Property AFTER Contribution Date determines the remaining Gain/Loss Character (Applies to dispositions within 5 years of Contribution) (e.G., Diego has a BIL, held for Investment Purposes (Capital) & Partnership who sell & buy real estate simply sold the Land (Ordinary) → Diego has a Pre-Contribution Capital Loss, rest is Ordinary) 2. Built-in Capital Gains & Ordinary Losses → “How Property Used” Rule – How the Partnership used the Property since the Date of Contribution determines the Total Gain/Loss Character (e.G., Diego has a BIG, held for Investment Purposes (Capital) & Partnership who sell & buy real estate simply sold the Land (Ordinary) → Ordinary to ALL) 3.”How Property Used” Rule is the General Rule & therefore used for ALL Post-Contribution Gain/Loss Partnership Operations: 1. Ordinary vs. Separately Stated Items – Separately Stated Items (Schedule K) = Net Short and Long-Term Capital Gains/Losses, §1231 Gains/Losses, Charitable Contributions, Portfolio Income Items (Dividends, Interest, & Royalties), Expenses related to Portfolio Income Items, §179 Deductions, Special Allocations, Recovery of Items Previously Deducted (Tax Benefit Items), AMT preference & Adjustment Items, Self-Employment Income, Passive Activity Items, Taxes Paid to Foreign Countries & U.S. Possessions, & Non-Business & Personal Items (Get All Ordinary Items to get Ordinary Income → take the Ordinary Income as well as the Separately Stated Items → multiply each by the Partner’s Ownership % to get their Schedule K-1) 2. Guaranteed Payments:
Are both Ordinary Deductions & Separately Stated Items → Deductible & creates an Ordinary Loss for the Partnership & a Taxable Ordinary Income item for the Partner (Cannot be determined by reference to Partnership Income) (% of Partnership Income Received → Distribution) 3. Special Allocations:
For Certain Items to Specified Partners in a Partnership Agreement (Must produce Non-Tax Economic consequences for the Partners receiving it) Inside Basis vs. Outside Basis vs. Tax Basis Capital Account:
1. Initial Basis = Substitute Basis of Property Transferred + Debt allocated to Partner + FMV of Services (if Capital Interest in Partnership) 2. Pre-Existing Partnership Interest – Purchased from Partner → Initial Basis = Cost, Acquired by Gift → Initial Basis = Carryover Basis, Acquired by Inheritance → Initial Basis = FMV on Date of Death 3. Outside Basis = Initial Basis + Partner’s Subsequent Contributions + Partner’s Share (multiply by %) of Partnership’s → (+) Debt Increase, Taxable Income Items, Tax-Exempt Income Items, Excess of Depletion Deductions over Property Basis – Partner’s Distributions & Withdrawals – Partner’s Share (multiply by %) of Partnership’s → (-) Debt Decrease, Non-Deductible Items NOT chargeable to a Capital Account, Special Depletion Deduction for oil & gas wells, Expense & Loss Items (Simplified → Outside Basis (NEVER Negative) = Partner’s Tax Basis Capital Account + Partner’s Share of Debt + Tax-Exempt Income Items – Nondeductible Items) 4. How Liabilities Affect Basis – An increase in a Partner’s Share of Partnership debt is a Cash Contribution by the Partner to the Partnership, & a decrease is a Cash Distribution by the Partnership to the Partner. Recourse Debt (Personally Liable)–
If more than one General Partner, allocate using the ‘Constructive Liquidation Scenario’ → Start with their Capital Accounts, Partnership Assets are sold at FMV ($0) and Losses on the deemed sales are determined, these Losses are allocated to the Partners according to their Loss Sharing Ratios and Reduce the Partners’ Capital Accounts, any Partner with a Negative Capital Account balance is treated as Contributing Cash to the Partnership to restore that Negative balance to zero, the Cash deemed contributed by the Partners with Negative Capital balances is used to pay the Liabilities of the Partnership, and the Partnership is deemed to be Liquidated immediately, and any remaining Cash is Distributed to Partners with Positive Capital Account balances (E.G., Start with Capital Account for Each Partner Less Allocated (%) Total Asset Loss = Negative → Cash Contribution, so Positive Plus Capital Amount) Non-Recourse Debt (Allocated in 3 Stages) –
1. Minimum Gain (Use if Debt > Book Basis) is the excess of Non-Recourse Debt – Book Basis of the Contributed Property 2. IRC §704(c) Debt (Use if Debt > Tax Basis) is the excess of Non-Recourse Debt – Tax Basis of the Contributed Property 3. Any remaining Non-Recourse Debt is allocated according to their Profit-Sharing Ratios Deducting Losses of the Partnership (Compare Loss to each one & Deduct the Lesser Limit (if it Applies) when Loss > Limit)–
(Suspended (Can’t Deduct) Losses are Carried Forward Indefinitely)
1. Overall Limitation (Outside Basis)
Allows Partners to Deduct Losses to the extent each Partner has Basis (Ending Outside Basis) in their Partnership Interest 2. Losses that pass the Overall Limitation are Deductible under the ‘At-Risk’ Limitation–
To the extent of the Partner’s At-Risk Basis, which removes Non-Qualified Non-Recourse Debt from Outside Basis (i.E., debt secured by non-real property) 3. Losses that survive the Overall & At-Risk Limitations are subject to the Passive Loss Limitation–
Limited by Passive Income → Daily Involvement in Operations (e.G., A Limited Partner)
Chapter 21:
(Hot Assets when disposed causes the Partner to Recognize Ordinary Income, it includes: Unrealized Receivables (including Depreciation Recapture Potential), Accounts Receivable, BIG Recapture, and Inventory) (Debt Decrease is a Cash Distribution) (A Reduction in a Partner’s Share of Partnership Liabilities First reduces the Partner’s Basis) (If the Whole Partnership reduces its Liabilities → Multiply Partner’s % to get Debt Decrease)
Sales of Partnership Interests:
Selling Partner’s Share of Liabilities must be included in both their Outside Basis and as consideration received from the Sale (Selling Partner’s Capital Account carries over to the New Partner). The Purchasing Partner includes any Liabilities assumed from the Partnership as part of the consideration paid.
1. Calculation
Capital Account = Contribution + Partnership Income/Loss – Distribution (withdrew)
Outside Basis = Share of Liability + Capital Account (If Selling Full Partnership Interest → Ending OB = 0)
Total Gain/Loss (Selling Partner)
= Amount Realized (FMV Consideration Received → Amount Sold + Debt Decrease → Share of Liability) – Outside Basis Initial Outside Basis (Purchasing Partner)
= FMV Consideration Paid (Amount Sold) + Allocable Share of Partnership Debt (Share of Liability)
2. Determining Character of Gain/Loss
Step 1
Total Gain/Loss = Amount Realized on Sale (Amount Sold + Share of Liability) – Partner’s Outside Basis Step 2.
Ordinary Gain/Loss = Partner’s Share of Gain/Loss from Hot Assets, if the Partnership Sold these Assets at FMV ((FMV – Adj. Basis) x %)
Step 3
Capital Gain/Loss = Total Gain/Loss from Step 1 – Ordinary portion of Gain/Loss from Step 2
Summary of Distribution Effects:
1. Non-Liquidating Distributions → IF Outside Basis > Distributed Asset Inside Basis, use Carryover Basis (General Rule) IF Outside Basis < Distributed Asset Inside Basis, use Relative Basis Method (Ending O/B = 0)
2. Liquidating Distributions → IF Outside Basis > Distributed Asset Inside Basis, use Relative FMV Method (Ending O/B = 0) IF Outside Basis < Distributed Asset Inside Basis, use Relative Basis Method (Ending O/B = 0)
Proportionate Operating (i.E., Non-Liquidating Distributions):
1. General Rule–
NO Gain/Loss Recognized (Look at 2)
, The (receiving) Partner takes a Carryover Basis in Distributed Assets (Inside Basis in Assets) (Non-Cash)
(Look at 3)
, The (receiving) Partner’s Outside Basis is Reduced (NEVER below 0) by the Amount of Cash Received (including Debt Decrease → Share of Liability) + Adjusted Basis of Distributed Assets (Inside Basis of Assets Received)
2. Exception to the “No Gain” Rule
A Partner Recognizes a Capital Gain IF Cash Received + Debt Decrease > Outside Basis (No Gain IF Debt Decrease (deemed Cash Distribution) < Outside Basis) (Ending Outside Basis = Outside Basis + Capital Gain – Cash)
3. Exception to the Carryover Basis Rule
If Partner’s Outside Basis < Basis of Distributed Assets (Inside Basis) → Partner takes the Substituted Basis. Allocate Outside Basis to Distributed Assets in this order – #1 Cash, #2 Hot Assets (e.G., Unrealized Receivables & Inventory), #3 All Other Assets (aka “the last class”)
(Look at 4)
(Ending Outside Basis = 0) (Example: OB = 75k, Cash is 15k, Inventory Basis = 40k, Building Basis = 75k → Cash Basis = 15k (75k – 15k = 60k remaining) Inventory Basis = 40k (60k – 40k = 20k remaining) Building = 20k Substitute Basis (20k remaining – 20k))
4. Relative Basis Method (O/B < I/B)–
(For Multiple “Last Class” Assets) Follow these Steps –
#1
Each Distributed Asset within “the Last Class” initially takes a Carryover Basis #2
Write-down the Carryover Basis of each asset that has a Carryover Basis > FMV (Carryover Basis CANNOT be reduced below FMV)
#3
Allocate any remaining Decrease in Outside Basis among the Distributed Assets in proportion to their respective Adjusted Basis (For each “Last Class” Asset = (Asset Basis / Total Asset Basis) x Remaining Outside Basis)
Proportionate Liquidating Distributions:
1. Partnership & Partner’s Interest is Terminating
Partner’s Ending Outside Basis MUST equal zero, NO Gain/Loss Recognized by the Partnership, NO Gain/Loss Recognized by the Partner (Look at 2)
2. Exception to No Gain/Loss from Partner
Capital Gain
Recognition IF Cash + Debt Decrease (Share of Liability) > Partner’s Outside Basis Capital Loss
Recognition IF Partner Receives ONLY Cash + Hot Assets (A/R & Inventory) AND Partner’s Outside Basis > Basis of Distributed Assets (Inside Basis) (If Received any other Asset, No Loss Recognition)
3. Multiple Asset Distribution
(Ordering Rules (Cash, Hot Assets, Last Class)
& Relative Basis Method are the Same
Unrealized Receivables & Inventory can be stepped-down, but NEVER stepped-up, but All Other Assets can be stepped-up or stepped-down (When one “Last Class” Asset Distributed → It takes a Substitute Basis) (Example: OB = 75k, Cash is 25k, Inventory Basis = 10k, Building Basis = 15k → Cash Basis = 25k (75k – 25k = 50k remaining) Inventory Basis = 10k (50k – 10k = 40k remaining) Building = 40k Substitute Basis (stepped-up basis to remaining 40k)
4. Relative FMV Method (O/B > I/B)
(For Multiple “Last Class” Assets) Follow these Steps –
#1
Each Distributed Asset within “the Last Class” initially takes a Carryover Basis (Even Assets in the Last Class)
#2
Write-up the Carryover Basis of each asset that has a Carryover Basis < FMV (Carryover Basis CANNOT be increased by FMV)
#3
Allocate remaining Outside Basis (after ALL assets have been distributed, subtract Remaining with each “Last Class” Basis)
Among the Assets in the “Last Class” in proportion to their respective FMVs (For each “Last Class” Asset = Their Basis + Any Remaining Basis Leftover x (Asset FMV / Total FMVs))