Question & Answer

82. LeBron, Dennis, and Susan formed the Bar T LLC at the beginning of the current year. LeBron and Dennis each contributed $200,000 and Susan transferred several acres of agricultural land she had purchased two years earlier to the LLC. The land had a tax basis of $50,000 and was appraised at $300,000. The land was also encumbered with a $100,000 nonrecourse mortgage (i.e., qualified nonrecourse financing) for which no one was personally liable. The members plan to use the land and cash to begin a cattle-feeding operation. Susan will work full time operating the business, but LeBron and Dennis will devote less than two days per year to the operation.

All three members agree to split profits and losses equally. At the end of the first year, Bar T had accumulated $40,000 of accounts payable jointly guaranteed by LeBron and Dennis and had made a $9,000 principal payment on the mortgage. None of the members have passive income from other sources or business income from other sources. LeBron and Dennis are married, while Susan is single.

For the first year of operations, the partnership records disclosed the following information:

Sales revenue $620,000

Cost of goods sold $380,000

Operating expenses $670,000

Dividends $1,200

Municipal bond interest $300

Salary paid as a guaranteed payment to Susan (not included in expenses) $10,000

Cash distributions split equally among the members at year-end $3,000

a. Compute the tax basis of each member’s interest immediately after the formation of the LLC.

b. When does each member’s holding period for his or her LLC interests begin?

c. What are Bar T’s tax basis and holding period in its land?

d. What is Bar T’s required tax year-end?

e. What overall methods of accounting were initially available to Bar T?

f. List the separate items of partnership income, gains, losses, deductions, and other items that will be included in each member’s Schedule K-1 for the first year of operations. Use the proposed self-employment tax regulations to determine each member’s self-employment income or loss.

g. What are the members’ tax bases in their LLC interests at the end of the first year of operations?

h. What are the members’ at-risk amounts in their LLC interests at the end of the first year of operations?

i. How much loss from Bar T, if any, will the members be able to deduct on their individual returns from the first year of operations?

The TimpRiders LP has operated a motorcycle dealership for a number of years. Amir is the limited partner, Francesca is the general partner, and they share capital and profits equally. Francesca works full time managing the partnership. Both the partnership and the partners report on a calendar-year basis. At the start of the current year, Amir and Francesca had bases of $10,000 and $3,000 respectively, and the partnership did not have any liabilities. During the current year, the partnership reported the following results from operations:

Net sales $650,000

Cost of goods sold $500,000

Operating expenses $160,000

Short-term capital loss $2,000

Tax-exempt interest $2,000

§1231 gain $6,000

On the last day of the year, the partnership distributed $3,000 each to Amir and Francesca.

a. What outside basis do Amir and Francesca have in their partnership interests at the end of the year?

b. How much of their losses are currently not deductible by Amir and Francesca because of the tax-basis limitation?

c. To what extent does the passive activity loss limitation apply in restricting their deductible losses for the year?

d. Using the information provided, prepare TimpRiders’ page 1 and Schedule K to be included with its Form 1065 for the current year. Also, prepare a Schedule K-1 for Amir and Francesca.

Aaron, Deanne, and Keon formed the Blue Bell General Partnership at the beginning of the current year. Aaron and Deanne each contributed $110,000 and Keon transferred an acre of undeveloped land to the partnership. The land had a tax basis of $70,000 and was appraised at $180,000. The land was also encumbered with a $70,000 nonrecourse mortgage for which no one was personally liable. All three partners agreed to split profits and losses equally. At the end of the first year, Blue Bell made a $7,000 principal payment on the mortgage. For the first year of operations, the partnership records disclosed the following information:

Sales revenue $470,000

Cost of goods sold $410,000

Operating expenses $70,000

Long-term capital gains $2,400

§1231 gains $900

Charitable contributions $300

Municipal bond interest $300

Salary paid as a guaranteed payment to Deanne (not included in expenses) $3,000

a. Compute the adjusted basis of each partner’s interest in the partnership immediately after the formation of the partnership.

b. List the separate items of partnership income, gains, losses, and deductions that the partners must show on their individual income tax returns that include the results of the partnership’s first year of operations.

c. Using the information generated in answering parts (a) and (b), prepare Blue Bells’ page 1 and Schedule K to be included with its Form 1065 for its first year of operations along with Schedule K-1 for Deanne.

d. What are the partners’ adjusted bases in their partnership interests at the end of the first year of operations?

Ray and Matias each own 50 percent capital and profits interests in Alpine Properties LLC. Alpine builds and manages rental real estate, and Ray and Matias each work full time (over 1,000 hours per year) managing Alpine. Alpine’s liabilities (at both the beginning and end of the year) consist of $1,500,000 in nonrecourse mortgages obtained from an unrelated bank and secured by various rental properties. At the beginning of the current year, Ray and Matias each had a tax basis of $250,000 in his LLC interest, including his share of the nonrecourse mortgage liability. Alpine’s ordinary business losses for the current year totaled $600,000, and neither member is involved in other activities that generate passive income.

a. How much of each member’s loss is suspended because of the tax-basis limitation?

b. How much of each member’s loss is suspended because of the at-risk limitation?

c. How much of each member’s loss is suspended because of the passive activity loss limitation? [Hint: See §469(c)(7).]

d. If both Ray and Matias are single and Ray has a current-year loss of $100,000 from a sole proprietorship, how much trade or business loss can each deduct on his tax return in the current year?

Suki and Steve own 50 percent capital and profits interests in Lorinda LLC. Lorinda operates the local minor league baseball team and owns the stadium where the team plays. Although the liability incurred to build the stadium was paid off several years ago, Lorinda owes its general creditors $300,000 (at the beginning of the year) that is not secured by firm property or guaranteed by any of the members. At the beginning of 2024, Suki and Steve had a tax basis of $170,000 in their LLC interests, including their share of liabilities owed to the general creditors. Shortly before the end of the year, they each received a $10,000 cash distribution, even though Lorinda’s ordinary business loss for the year was $400,000. Because of the time commitment to operate a baseball team, both Suki and Steve spent more than 1,500 hours during the year operating Lorinda. Both Suki and Steve are single, and neither of them has any business income or losses from other sources.

a. Determine how much of the Lorinda loss Suki and Steve will each be able to deduct on their current tax returns, and list their losses suspended by the tax basis, at-risk, and passive activity loss limitations.

b. Assume that sometime before receiving the $10,000 cash distribution, Steve is advised by his tax advisor that his marginal tax rate will be abnormally high during the current year because of an unexpected windfall. To help Steve utilize more of the losses allocated from Lorinda in the current year, his advisor recommends refusing the cash distribution and personally guaranteeing $100,000 of Lorinda’s liabilities, without the right to be reimbursed by Suki. If Steve follows his advisor’s recommendations, how much additional Lorinda loss can he deduct on his current tax return? How does Steve’s decision affect the amount of loss Suki can deduct on her current return and the amount and type of her suspended losses?

Jenkins has a one-third capital and profits interest in the Maverick General Partnership. On January 1, year 1, Maverick has $120,000 of general liabilities obligations and Jenkins has a $50,000 tax basis (including his share of Maverick’s liabilities) in his partnership interest. During the year, Maverick incurred a $30,000 nonrecourse liability that is not secured by real estate. Because Maverick is a rental real estate partnership, Jenkins is deemed to be a passive participant in Maverick. His share of the Maverick losses for year 1 is $75,000. Jenkins is not involved in any other passive activities, and this is the first year he has been allocated losses from Maverick.

a. Determine how much of the Maverick loss Jenkins will currently be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.

b. If Jenkins sells his interest on January 1, year 2, what happens to his suspended losses from year 1? [Hint: See §706(c)(2)(A); Reg. §1.704-1(d)(1); Prop. Reg. §1.465-66(a); and Sennett v. Comm’r, 80 TC 825 (1983).]

Farell is a member of Sierra Vista LLC. Although Sierra Vista is involved in a number of different business ventures, it is not currently involved in real estate either as an investor or as a developer. On January 1, year 1, Farell has a $100,000 tax basis in his LLC interest that includes his $90,000 share of Sierra Vista’s general liabilities. By the end of the year, Farell’s share of Sierra Vista’s general liabilities have increased to $100,000. Because of the time he spends in other endeavors, Farell does not materially participate in Sierra Vista. His share of the Sierra Vista losses for year 1 is $120,000. As a partner in the Riverwoods Partnership, he also has year 1, Schedule K-1 passive income of $5,000. Farell is single and has no other sources of business income or loss.

a. Determine how much of the Sierra Vista loss Farell will currently be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.

b. Assuming Farell’s Riverwoods K-1 indicates passive income of $30,000, determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.

c. Assuming Farell is deemed to be an active participant in Sierra Vista, determine how much of the Sierra Vista loss he will ultimately be able to deduct on his tax return for year 1, and list the losses suspended due to tax basis, at-risk, and passive activity loss limitations.

d. Assuming Farell is deemed to be an active participant in Sierra Vista, and he also has a $300,000 loss from a sole proprietorship, determine how much total trade or business loss Farell will deduct on his return in year 1.

Juan Diego began the year with a tax basis in his partnership interest of $50,000. During the year, he was allocated $20,000 of partnership ordinary business income, $70,000 of §1231 losses, $30,000 of short-term capital losses and received a cash distribution of $50,000.

a. What items related to these allocations does Juan Diego actually report on his tax return for the year? [Hint: See Reg. §1.704-1(d)(2) and Rev. Rul. 66-94.]

b. If any deductions or losses are limited, what are the carryover amounts, and what is their character? [Hint: See Reg. §1.704-1(d).]

Nareh began the year with a tax basis of $45,000 in her partnership interest. Her share of partnership liabilities consists of $6,000 of recourse liabilities and $10,000 of nonrecourse liabilities at the beginning of the year and $6,000 of recourse liabilities and $13,000 of nonrecourse liabilities at the end of the year. During the year, she was allocated $65,000 of partnership ordinary business loss. Nareh does not materially participate in this partnership, and she has $4,000 of passive income from other sources.

a. How much of Nareh’s loss is limited by her tax basis?

b. How much of Nareh’s loss is limited by her at-risk amount?

c. How much of Nareh’s loss is limited by the passive activity loss rules?

Nareh began the year with a tax basis of $45,000 in her partnership interest. Her share of partnership liabilities consists of $6,000 of recourse liabilities and $10,000 of nonrecourse liabilities at the beginning of the year and $6,000 of recourse liabilities and $13,000 of nonrecourse liabilities at the end of the year. During the year, she was allocated $65,000 of partnership ordinary business loss. Nareh does not materially participate in this partnership, and she has $4,000 of passive income from other sources.

a. How much of Nareh’s loss is limited by her tax basis?

b. How much of Nareh’s loss is limited by her at-risk amount?

c. How much of Nareh’s loss is limited by the passive activity loss rules?

Alfonso began the year with a tax basis in his partnership interest of $30,000. His share of partnership liabilities at the beginning and end of the year consists of $4,000 of recourse liabilities and $6,000 of nonrecourse liabilities. During the year, he was allocated $40,000 of partnership ordinary business loss. Alfonso does not materially participate in this partnership, and he has $1,000 of passive income from other sources.

a. How much of Alfonso’s loss is limited by his tax basis?

b. How much of Alfonso’s loss is limited by his at-risk amount?

c. How much of Alfonso’s loss is limited by the passive activity loss rules?

Laura Davis is a member in a limited liability company that has historically been profitable but is expecting to generate losses in the near future because of a weak local economy. In addition to the hours she works as an employee of a local business, she currently spends approximately 150 hours per year helping to manage the LLC. Other LLC members each work approximately 175 hours per year each in the LLC, and the time Laura and other members spend managing the LLC has remained constant since she joined the company three years ago. Laura’s tax basis and amount at-risk are large compared to her share of projected losses; however, she is concerned that her ability to deduct her share of the projected losses will be limited by the passive activity loss rules.

a. As an LLC member, will Laura’s share of losses be presumed to be passive as they are for limited partners? Why or why not? [Hint: See §469(h)(2); Garnett v. Comm’r, 132 TC 368 (2009); and Prop. Reg. § 1.469-5(e)(3)(i).]

b. Assuming Laura’s losses are not presumed to be passive, is she devoting sufficient time to the LLC to be considered a material participant? Why or why not?

c. What would you recommend to Laura to help her achieve a more favorable tax outcome?

Pam, Sergei, and Mercedes are all one-third partners in the capital and profits of Oak Grove General Partnership. Partnership liabilities are allocated among the partners in accordance with their capital and profits interests. In addition to their normal share of the partnership’s annual income, Pam and Sergei receive annual guaranteed payments of $20,000 each to compensate them for additional services they provide. Oak Grove’s income statement for the current year reflects the following revenues and expenses:

Sales revenue $476,700

Dividend income 6,600

§1231 losses (3,800)

Cost of goods sold (245,000)

Employee wages (92,000)

Depreciation expense (31,000)

Guaranteed payments (40,000)

Miscellaneous expenses (11,500)

Overall net income $ 60,000

In addition, Oak Grove owed creditors $90,000 at the beginning of the year and $150,000 at the end, and Pam, Sergei and Mercedes had a tax basis of $50,000 in their interests at the beginning of the year. Also, on December 31 of the current year, Sergei and Mercedes agreed to increase Pam’s capital and profits interest from 1∕3 to 40 percent in exchange for additional services she provided to the partnership. The current liquidation value of the additional capital interest Pam received at the end of the tax year is $40,000.

a. What tax basis do the partners have in their partnership interests at the end of the year?

b. If, in addition to the expenses listed above, the partnership donated $12,000 to a political campaign, what tax basis do the partners have in their partnership interests at the end of the year assuming the liquidation value of the additional capital interest Pam receives at the end of the year remains at $40,000?

Oscar, Felix, and Marv are all one-third partners in the capital and profits of Eastside General Partnership. In addition to their normal share of the partnership’s annual income, Oscar and Felix receive annual guaranteed payments of $7,000 to compensate them for additional services they provide. Eastside’s income statement for the current year reflects the following revenues and expenses:

Sales revenue $ 420,000

Dividend income 5,700

Short-term capital gains 2,800

Cost of goods sold (210,000)

Employee wages (115,000)

Depreciation expense (28,000)

Guaranteed payments (14,000)

Miscellaneous expenses (9,500)

Overall net income $ 52,000

In addition, Eastside owed creditors $120,000 at the beginning of the year but managed to pay down its liabilities to $90,000 by the end of the year. All partnership liabilities are allocated equally among the partners. Finally, Oscar, Felix and Marv had a tax basis of $80,000 in their interests at the beginning of the year.

a. What tax basis do the partners have in their partnership interests at the end of the year?

b. Assume the partners began the year with a tax basis of $10,000 and all the liabilities were paid off on the last day of the year. How much gain will the partners recognize when the liabilities are paid off? What tax basis do the partners have in their partnership interests at the end of the year?

Carmine was allocated the following items from the Piccolo LLC for last year:

Ordinary business loss

Nondeductible penalties

Tax-exempt interest income

Short-term capital gain

Cash distributions

Rank these items in terms of the order they should be applied to adjust Carmine’s tax basis in Piccolo for the year (some items may be of equal rank).

Mustafa’s tax basis in his partnership interest at the beginning of the year was $10,000. If his share of the partnership liabilities increased by $10,000 during the year and his share of partnership income for the year is $3,000, what is his tax basis in his partnership interest at the end of the year?

Lane and Cal each own 50 percent of the profits and capital of HighYield LLC. HighYield owns a portfolio of taxable bonds and municipal bonds, and 

This year, Agustin’s distributive share from Eden Lakes Partnership includes $8,000 of interest income, $4,000 of net long-term capital gains, $2,000 net §1231 gain from the sale of property used in the partnership’s trade or business, and $83,000 of ordinary business income.

a. Assume that Agustin materially participates in the partnership. How much of his distributive share from Eden Lakes Partnership is potentially subject to the net investment income tax?

b. Assume that Agustin does not materially participate in the partnership. How much of his distributive share from the Eden Lakes partnership is potentially subject to the net investment income tax?

This year, Darrel’s distributive share from Alcove Partnership includes $6,000 of interest income, $3,000 of dividend income, and $70,000 ordinary business income.

a. Assume that Darrel materially participates in the partnership. How much of his distributive share from Alcove Partnership is potentially subject to the net investment income tax?

b. Assume that Darrel does not materially participate in the partnership. How much of his distributive share from Alcove Partnership is potentially subject to the net investment income tax?

Jhumpa, Stewart, and Kelly are all one-third partners in the capital and profits of Firewalker General Partnership. In addition to their normal share of the partnership’s annual income, Jhumpa and Stewart receive an annual guaranteed payment of $10,000 each to compensate them for additional services they provide. Firewalker’s income statement for the current year reflects the following revenues and expenses:

Sales revenue $340,000

Interest income 3,300

Long-term capital gains 1,200

Cost of goods sold (120,000)

Employee wages (75,000)

Depreciation expense (28,000)

Guaranteed payments (20,000)

Miscellaneous expenses (4,500)

Overall net income $97,000

On the last day of its current tax year, Buy Rite LLC received $300,000 when it sold a machine it had purchased for $200,000 three years ago to use in its business. At the time of the sale, the basis in the equipment had been reduced to $100,000 due to tax depreciation taken. How much did the members’ self-employment earnings from Buy Rite increase when the equipment was sold? [Hint: See §1402(a)(3).]

Hoki Poki, a cash-method general partnership, recorded the following items for its current tax year:

Rental real estate income $2,000

Sales revenue $70,000

§1245 recapture income $8,000

Interest income $2,000

Cost of goods sold ($38,000)

Depreciation – MACRS ($9,000)

Supplies expense ($1,000)

Employee wages ($14,000)

Investment interest expense ($1,000)

Partner’s medical insurance premiums paid by Hoki Poki ($3,000)

As part of preparing Hoki Poki’s current-year return, identify the items that should be included in computing its ordinary business income (loss) and those that should be separately stated. [Hint: See Schedule K-1 and related preparer’s instructions at www.irs.gov.]

The partnership agreement of the G&P general partnership states that Gary will receive a guaranteed payment of $13,000, and that Gary and Prudence will share the remaining profits or losses in a 45∕55 ratio. For year 1, the G&P partnership reports the following results:

Richard Mendez and two friends from law school recently formed Mendez and Associates as a limited liability partnership (LLP). Income from the partnership will be split equally among the partners. The partnership will generate fee income primarily from representing clients in bankruptcy and foreclosure matters. While some attorney friends have suggested that the partners’ earnings will be self-employment income, other attorneys they know from their local bar association meetings claim just the opposite. After examining relevant authority, explain how you would advise Mendez and Associates on this matter. [Hint: See §1402(a)(13) and Renkemeyer, Campbell & Weaver LLP v. Commissioner, 136 T.C. 137 (2011).]

1.      Georgio owns a 20 percent profits and capital interest in Rain Tree LLC. For the current year, Rain Tree had the following revenues, expenses, gains, and losses:

Turtle Creek Partnership had the following revenues, expenses, gains, losses, and distributions: