Question & Answer

Ashlee, Hiroki, Kate, and Albee LLC each own a 25 percent interest in Tally Industries LLC, which generates annual gross receipts of over $10 million. Ashlee, Hiroki, and Kate manage the business, but Albee LLC is a nonmanaging member. Although Tally Industries has historically been profitable, for the last three years losses have been allocated to the members. Given these facts, the members want to know whether Tally Industries can use the cash method of accounting. Why or why not? [Hint: See §448(b)(3).]

Ryan, Dahir, and Bill have operated Broken Feather LLC for the last four years using a calendar year-end. Each has a one-third interest. Since they began operating, their busy season has run from June through August, with 35 percent of their gross receipts coming in July and August. The members would like to change their tax year-end and have asked you to address the following questions:

a. Can they change to an August 31 year-end and, if so, how do they make the change? [Hint: See Rev. Proc. 2002-38.]

b. Can they change to a September 30 year-end and, if so, how do they make the change? [Hint: See §444.]

Rock Creek LLC was recently formed with the following members:

Name Tax Year-End Capital/Profits %

Mark Banks December 31 35%

Highball Properties LLC March 31

25%

Chavez Builders Inc. November 30 40%

What is the required taxable year-end for Rock Creek LLC?

Tall Tree LLC was recently formed with the following members:

Name Tax Year-End Capital/Profits %

Eddie Robinson December 31 40%

Pitcher Lenders LLC June 30 25%

Perry Homes Inc. October 31 35%

What is the required taxable year-end for Tall Tree LLC?

Granite Slab LLC was recently formed with the following members:

1.      Broken Rock LLC was recently formed with the following members:

What is the required taxable year-end for Broken Rock LLC?

Last December 31, Ramon sold the 10 percent interest in the Del Sol Partnership, which he had held for two years to Garrett for $400,000. Prior to selling his interest, Ramon’s basis in Del Sol was $200,000, which included a $100,000 share of nonrecourse liabilities allocated to him.

a. What is Garrett’s tax basis in his partnership interest?

b. If Garrett sells his partnership interest three months after receiving it and recognizes a gain, what is the character of his gain?

Dave LaCroix recently received a 10 percent capital and profits interest in Cirque Capital LLC in exchange for consulting services he provided. If Cirque Capital had paid an outsider to provide the advice, it would have deducted the payment as compensation expense. Cirque Capital’s balance sheet on the day Dave received his capital interest appears below:

Assets: Basis Fair Market Value

Cash $ 150,000 $ 150,000

Investments 200,000 700,000

Land 150,000 250,000

Totals $ 500,000 $1,100,000

Liabilities and capital:

Nonrecourse liabilities 100,000 100,000

Tatsuki* 200,000 500,000

Robert* 200,000 500,000

Totals $ 500,000 $ 1,100,000

Mary and Scott formed a partnership that maintains its records on a calendar-year basis. The balance sheet of the MS Partnership at year-end is as follows:

Basis Fair Market Value

Cash $ 60 $ 60

Land 60 180

Inventory 72 60

$192 $300

Mary $ 96 $150

Scott 96 150

$192 $300

Connie recently provided legal services to the Winterhaven LLC and received a 5 percent interest in the LLC as compensation. Winterhaven currently has $50,000 of accounts payable and no other liabilities. The current fair market value of Winterhaven’s capital is $200,000.

a. If Connie receives a 5 percent capital interest only, how much income must she report, and what is her tax basis in the LLC interest?

b. If Connie receives a 5 percent profits interest only, how much income must she report, and what is her tax basis in the LLC interest?

c. If Connie receives a 5 percent capital and profits interest, how much income must she report, and what is her tax basis in the LLC interest?

Kamal contributed $10,000 in cash and a capital asset he had held for three years with a fair market value of $20,000 and tax basis of $10,000 for a 5 percent capital and profits interest in Green Valley LLC.

a. If Kamal sells his LLC interest 13 months later for $30,000 when the tax basis in his partnership interest is still $20,000, how much gain does he report, and what is its character?

b. If Kamal sells his LLC interest two months later for $30,000 when the tax basis in his partnership interest is still $20,000, how much gain does he report, and what is its character? [Hint: See Reg. §1.1223-3.]

Claude purchased raw land three years ago for $1,500,000 to develop into lots and sell to individuals planning to build their dream homes. Claude intended to treat this property as inventory, like his other development properties. Before completing the development of the property, however, he decided to contribute it to South Peak Investors LLC when it was worth $2,500,000, in exchange for a 10 percent capital and profits interest. South Peak’s strategy is to hold land for investment purposes only and then sell it later at a gain.

a. If South Peak sells the property for $3,000,000 four years after Claude’s contribution, how much gain or loss is recognized and what is its character? [Hint: See §724.]

b. If South Peak sells the property for $3,000,000 five and one-half years after Claude’s contribution, how much gain or loss is recognized, and what is its character?

Ansel purchased raw land three years ago for $200,000 to hold as an investment. After watching the value of the land drop to $150,000, he decided to contribute it to Mountainside Developers LLC in exchange for a 5 percent capital and profits interest. Mountainside plans to develop the property and will treat it as inventory, like all of the other real estate it holds.

a. If Mountainside sells the property for $150,000 after holding it for one year, how much gain or loss does it recognize, and what is the character of its gain or loss? [Hint: See §724.]

b. If Mountainside sells the property for $125,000 after holding it for two years, how much gain or loss does it recognize, and what is the character of the gain or loss?

c. If Mountainside sells the property for $150,000 after holding it six years, how much gain or loss is recognized, and what is the character of the gain or loss?

Malak has decided to contribute some equipment she previously used in her sole proprietorship in exchange for a 10 percent profits and capital interest in Fast Choppers LLC. Malak originally paid $200,000 cash for the equipment. Since then, the tax basis in the equipment has been reduced to $100,000 because of tax depreciation, and the fair market value of the equipment is now $150,000.

a. Must Malak recognize any of the potential §1245 recapture when she contributes the machinery to Fast Choppers? [Hint: See §1245(b)(3).]

b. What cost recovery method will Fast Choppers use to depreciate the machinery? [Hint: See §168(i)(7).]

c. If Fast Choppers were to immediately sell the equipment Malak contributed for $150,000, how much gain would Malak recognize, and what is its character? [Hint: See §§1245 and 704(c).]

Kevan, Jerry, and Dave formed Albee LLC. Jerry and Dave each contributed $245,000 in cash. Kevan contributed the following assets: 

Kevan: Basis Fair Market Value

Cash $ 15,000 $ 15,000

Land* 120,000 440,000

Totals $ 135,000 $ 455,000

When High Horizon LLC was formed, Maude contributed the following assets in exchange for a 25 percent capital and profits interest in the LLC:

Maude: Basis Fair Market Value

Cash $ 20,000 $ 20,000

Land* 100,000 360,000

Totals $ 120,000 $ 380,000

Cosmo contributed land with a fair market value of $400,000 and a tax basis of $90,000 to the Y Mountain partnership in exchange for a 25 percent profits and capital interest in the partnership. The land is secured by a $120,000 nonrecourse liability. Other than this nonrecourse liability, Y Mountain partnership does not have any liability.

a. How much gain will Cosmo recognize from the contribution?

b. What is Cosmo’s tax basis in his partnership interest?

Harry and Sally formed the Evergreen Partnership by contributing the following assets in exchange for a 50 percent capital and profits interest in the partnership:

Harry: Basis Fair Market Value

Cash $ 30,000 $ 30,000

Land 100,000 120,000

Totals $ 130,000 $ 150,000

Sally:

Equipment used in a business $200,000 $150,000

Totals $ 200,000 $ 150,000

a. How much gain or loss will Harry recognize on the contribution?

b. How much gain or loss will Sally recognize on the contribution?

c. How could the transaction be structured a different way to get a better result for Sally?

d. What is Harry’s tax basis in his partnership interest?

e. What is Sally’s tax basis in her partnership interest?

f. What is Evergreen’s tax basis in its assets?

g. Following the format in Exhibit 20-2, prepare a tax basis balance sheet for the Evergreen Partnership showing the tax capital accounts for the partners.

Rania contributed equipment worth $200,000, purchased 10 months ago for $250,000 cash and used in her sole proprietorship, to Sand Creek LLC in exchange for a 15 percent profits and capital interest in the LLC. Rania agreed to guarantee all $15,000 of Sand Creek’s accounts payable, but she did not guarantee any portion of the $100,000 nonrecourse mortgage securing Sand Creek’s office building. Other than the accounts payable and mortgage, Sand Creek does not have any liabilities to other creditors.

a. What is Rania’s initial tax basis in her LLC interest?

b. What is Rania’s holding period in her interest?

c. What is Sand Creek’s initial basis in the contributed property?

d. What is Sand Creek’s holding period in the contributed property?

Lance contributed investment property worth $500,000, purchased three years ago for $200,000 cash, to Cloud Peak LLC in exchange for an 85 percent profits and capital interest in the LLC. Cloud Peak owes $300,000 to its suppliers but has no other liabilities.

a. What is Lance’s tax basis in his LLC interest?

b. What is Lance’s holding period in his interest?

c. What is Cloud Peak’s basis in the contributed property?

d. What is Cloud Peak’s holding period in the contributed property?

Joseph contributed $22,000 in cash and equipment with a tax basis of $5,000 and a fair market value of $11,000 to Berry Hill Partnership in exchange for a partnership interest.

a. What is Joseph’s tax basis in his partnership interest?

b. What is Berry Hill’s basis in the equipment?

Under what circumstances can partners with passive losses from partnerships deduct their passive losses?

How do partners determine whether they are passive participants in partnerships when applying the passive activity loss limitation rules?

In what order are the loss limitation rules applied to limit partners’ losses from partnerships?

How do partners measure the amount they have at risk in the partnership?