general partnership exists ______
any time two or more partners join together and do not specifically provide that one or more of the partners is a limited partner.
General partnership rules
- 1. each partner has the right to participate in the management
- 2. flexible enough to allow a single partner to manage
- 3. each partner has the ability to make commitments for the partnership
- 4. each partner has unlimited liability for all partnership debts
- has two classes of partners.
- 1. must have at least one general partner
- 2. must have at least one limited partner
- - Can lose no more than his or her original investment plus any additional amount he or she has committed to contribute
- - have no right to be active in management
is a partnership formed under a state's limited partnership laws but that can elect to provide the general partners with limited liability
Businesses have the opportunity to be treated as a partnership for tax purposes while having limited liability protection for every owner.
Large partnership requirements
- 1. must not be a service partnership
- 2. must not be engaged in commodity trading
- 3. must have at least 100 partners throughout the tax year
- nontaxpaying entity
- - Each partner reports a share of the partnership's income, gain, loss, deduction, and credit items in his income tax return.
- - Each partner fills out a K-1 which calculates the tax liability for each partner
- Partnership interest is increased by his share of any liabilities.
- - increases by their share of partnership income and decreases by their share of the partnership losses.
- Basis can never be less than Zero
Partnership basis excess losses
If there are more losses than basis the excess loss is carried over to subsequent years and can be deducted once the partner gains sufficient basis again
If a cash distribution is so large that it exceeds their basis, the partner recognizes gain equal to the amount of the excess.
A loss may be recognized if a partner only recieves cash assets in complete liquidation of a partnership
Partnership contibution of property
- - partner recognizes no gain or loss
- - partnership recognizes no gain or loss
- - The partner's basis is the same as basis of the property transferred
Nonrecognition of gain or loss partnership
limited to transactions where a partner recieves a partnership in exchange for a contribution of property.
Property includes cash, tangible property, and intangible property but not services
Sec 721 exceptions recognition of gain or loss partnership
- a partner is required to recognize gain or loss on contribution of property for partnership interest if
- - contribution of property to a partnership that would be treated as an investment comany if it were incorporated (only report gains)
- - contribution of property followed by a distribution in an arrangement that may be considered a sale rather than a contribution.
- - the partner's share of liabilities exceeds his basis in the partnership
If the partner contributes property and has their liabilities assumed by the partnership
- - each partner's basis is increased by thier share of the partnership's liabilities as if they contributed cash to the partnership
- - the partner whose liabilities were assumed has a reduction in the basis of their partnership interest as if they were distributed cash.
- - A cash distribution first reduces the basis of a partner. If the distribution exceeds the partner's predistribution basis, the partner recognizes capital gain.
Holding period for partnership interest
Includes the tranferor's holding period for the contributed property if that property is a capital asset or Sec. 1231 asset in the transferor's hands.
If the contributed property is an ordinary income asset (inventory) to the partner, the holding period begins the day after the contribution date.
Partnership's basis in property
Sec 723, the partnerships basis is the same as the property basis in the hands of the contributing partner.
If a gain is realized because the partnership is an investment company, that gain increases the partnerships basis in the property.
If gain is recognized for assumption of liability it doesn't increase basis
Prevents the transformation of ordinary income into capital gains (or capital losses into ordinary losses)
any right to payment for goods or services the holder has not included in income because of the accounting method used.
- if a partner contributes these, any gain or loss recognized on the partnership's disposition or collection of the receivable is treated as ordinary income or loss, regardless of how long the partnership holds the receivable.
If property was inventory to the contributing partner, its character remains ordinary for 5 years.
Capital loss property
- Property that would generate a capital loss if sold by the contributing partner remains a capital loss if sold by the partnership for 5 years.
- However the amount of capital loss may not exceed the capital loss the contributing partner would have recognized had they sold the property on the contribution date. The character of the excess is based on the property's character in the hands of the partnership
Partnerships holding period
includes the holding period of the contributing partner, without regard to the character the property has in the contributing parterns hands
Section 1245 and 1250 partnerships
- the partner incurs no depreciation recapture unless they recognize gain upon contributing property in exchange for a partnership interest.
- - Both the adjusted basis and depreciation recapture potential carry over to the partnership.
- - If the partnership sells at a gain, Sec. 1245 and 1250 affect the character of the gain
Contribution of services
if they receive interest in a partnership in exchange for services, it is as if they were given cash and must recognize ordinary income.
Service in exchange for unrestricted partnership
requires the service partner to immediately recognize income equal to the FMV of the partnership interest less any cash or property contributed by the partner
Service in exchange for restricted partnership
partner recognizes no income upon receiving a restricted interest in a partnership until the restriction lapses or the interest can be freely transferred
Partnership interest components
Capital interest: can be valued by determining the amount the partner would receive if the partnership liquidated on the day the partner recieves the partnership interest. If the partner would receive proceeds from the sale or the assets themselves, they are considered to own a capital interest.
- If they're only interest is in future earnings the partner owns a profits interest (but not a capital interest.
Partnership tax year
determines when each partner reports their share of partnership income or loss
Separately stated items
- - net ST & LT capital gains and losses
- - Sec 1231 gains and losses
- - Unrecaptured Sec 1250 gains
- - Sec 179 expense
- - Charitable contributions
- - Dividends and interest income
- - Taxes paid to foreign country
- - tax-exempt interest
- - investment income & expenses
- - special allocations
Partnership ordinary income
All taxable items of income, gain, loss, or deduction that do not have to be separately stated
Partnership taxable income
the sum of all taxable items among the separately stated items plus the partnership ordinary income or loss.
Included in ordinary income
gross profit on sales, admin expenses, employee salaries. Sec 1245 recapture
includes rental and royalty income and income or losses from estates, trusts, S Corps, and partnerships.
US Production Deduction
applies at the partner level, so the partnership must report each partner's share of qualified production activities income on the partner's Sched K-1. For the 50% salary limitation, each partner is allocated a share of the partnership's W-2 wages.
Partner's distributive share
normally determined by the terms of the partnership agreement or by the partner's overall interest in the partnership.
-the portion of partnership taxable and nontaxable income that the partner has agreed to report for tax purposes.
If the partnership agreement states profit and loss percentages separately, _____
the partnership's taxable income is totaled to determine a net profit or loss, then the appropriate percentages apply to each class of income for the year
Special allocations Contributed Property
Sec 704 requires precontribution gains or losses to be allocated to the contributing partner. Income and deductions reported with respect to contributed property must be allocated to take into account the difference between the property's basis and FMV at the time of contribution.
Substantial economic effect: Economic effect
- -the allocation results in the appropriate increase or decrease in the partner's capital account
- - the proceeds of any liquidation occuring at any time in the partnership's life cycle are distributed in accordance with positive capital balances.
- - Partners must make up negative balances in their capital accounts upon the liquidation of the partnership, and these contributions are used to pay partnership debts or are allocated to partners having positive capital account balances
Substantial economic effect: substanial
-requires that a reasonable possibility exists that the allocation will substantially affect the dollar amounts to be received by the partners independent of tax consequences.
- Shifting does not qualify:
- - the net change in capital accounts will be the same for a normal allocation and the special allocation
- - the total tax liability of the partners will be less with the special allocation than with a normal allocation
Partners begining basis: purchasing from an existing partner
basis = price paid, including assumption of partnership liabilities
Basis if interest in partnership is inherited
basis = FMV of the partnership on the decedent's death
not less than liabilities assumed
Receive interest in partnership as gift
the donee's basis generally equals the donor's basis plus the portion of any gift tax paid by the donor that relates to appreciation attaching to the gift property
What are some of the common methods of acquiring a partnership interest and what is the begining basis?
- 1. Contribution - basis of contributed property
- 2. Purchase - purchase price
- 3. Inheritance - FMV
- 4. Gift - Donor's basis with gift tax adjustment
Change in liabilities considered cash contribution
1. An increase in the partner's share of partnership liabilities. (Arises from an increase in the partners profit or loss interests or from an increase in total partnership liabilities.)
2. Have the partner assume partnership liabilities in his or her individual capacity.
Change in liabilities considered cash distribution to partners
1. a decrease in a partners share of partnership liabilities and a decrease in the partner's individual liabilites resulting from the partnership's assumption of the partner's liability.
Steps to calculate the partner's basis in their partnership
- Take partner's basis before changes in liabilities
- 2. Add: Increases in share of partnership liabilities
- 3. Subtract: decreases in share of partnership liabilities
- 4. Add: Partnership liabilities assumed by the partner
- 5. Subtract: The partner's liabilities assumed by the partnership
- the usual kind of loan for which the borrower remains liable until the loan is paid.
- - if the recourse loan is secured and the borrower fails to make payments as scheduled, the lender can sell the property used as security.
- - if the sales proceeds are insufficient to repay a recourse loan, the borrower must make up the difference.
one in which the lender may sell property used as security if the loan is not paid, but no partner is liable for any deficiency.
increases a limited partner;s basis only to the extent the partner has a risk of economic loss.
increase a limited partner's basis based primarily on the profit ratio.
Partner's loss deduction
limited to the amount of their basis in the partnership before the loss. All positive basis adjustments, and all reductions for actual or deemed distributions must be made before determining the amount of the deductible loss
At-risk loss limitation
limit loss deductions to the partner's at-risk basis.
At-risk basis- essentially the same amount as the regular basis with the exception that liabilities increase the at-risk basis only if the partner is at risk for such an amount.
A partner is at risk for an amount if they would lose that amount should the partnership suddenly become worthless.
Exception to at-risk loss limitation
- Nonrecourse debt qualifies if
- - the financing is secured by real estate used in the partnership's real estate activity
- - the debt is not convertible to any kind of equity interest in the partnership
- - the financing from a qualified person or from and gov, is guaranteed by any govt. A qualified person is an unrelated party who is in the trade or business of lending money (bank, mortgage broker)
Passive activity limitations
- Income falls into three categories:
- 1. amounts derived from passive activities
- 2. active income such as salary, bonuses, and income from businesses in which the taxpayer materially participates
- 3. portfolio income such as dividends, interest, and capital gains from investments other than passive activities
Passive activity losses
- cannot be used to offset either active income or portfolio income, however they carry over to future years where they can offset passive income in those years.
- -passive losses are allowed in full when a taxpayer disposes of the entire interest in the passive activity.
- - a passive rental activity where a partner is an active participant can be deducted up to a maximum of $25,000 per year. (phases out by 50% of the AGI over $100,000)
Sales of property
- -no loss can be deducted on the sale or exchange of property between a partnership and a person who directly or indirectly owns more than 50% of the partnership's capital or profits interests.
- - losses are disallowed on sales or exchanges of property between two partnerships in which the same persons own, more than 50%
when a gain is recognized on the sale of a capital asset between a partnership and related partner, the gain is ordinary if the property will not be a capital asset to its new owner.
a partner who provides services to the partnership in an ongoing relationship might be compensated like any other employee. (includes certain payments made to a partner for the use of invested capital)
- -partnership interest must be a capital interest (gives partner right to receive assets if the partnership liquidates)
- - capital must be a material income
- -producing factor in the partnership's business activity
- - the family member must be the true owner of the interest
Donor-Donee allocations of income
- -Donor must be allocated reasonable compensation for services rendered to the partnership
- - After reasonable compensation is allocated to the donor, any remaining partnership income must be allocated based on relative capital interests.