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Case Study: Philly Limited Partnership Facts Rocky and Mick form Philly Limited Partnership (“Philly Partnership”). Rocky contributes $60 and Mick contributes $40. Philly Partnership uses the contributed cash to buy an asset for $100. Asset has a 10-year depreciable life, generating $10 of depreciation per year. Philly’s partnership agreement allocates net profits and losses as follows: Net losses are allocated 90% to Rocky and 10% to Mick until Rocky’s capital account is reduced to zero. Thereafter, all losses are allocated to Mick. Net profits are allocated in a manner to reverse prior loss allocations and then split 60% to Rocky and 40% to Mick. At the beginning of year 5, the asset is sold for $200 generating $140 of gain (assume no depreciation had been taken on the asset in year 5). For all five years net income or loss other than depreciation is zero. Requirements 1. Calculate Rocky and Mick’s distributive shares of partnership items for years 1-5. 2. Assuming the partnership liquidates at the end of year 5, calculate Rocky and Mick’s capital account balance immediately before the liquidating distribution and immediately after. Case Study: Ann Arbor Limited Partnership Facts Bo and Lloyd form Ann Arbor L. P. (“Ann Arbor”). Bo, the general partner, contributes $60 and Lloyd, the limited partner, contributes $40. The partnership agreement (the “Agreement”) requires capital account maintenance in accordance with Treas. Reg. 1.704-1(b)(2)(iv), and liquidation in accordance with positive capital account balances. If Ann Arbor liquidates, Lloyd has agreed to make up any deficit in his capital account in an amount not to exceed $10. Lloyd has no other obligation to contribute additional capital to Ann Arbor. The partnership has a loss of $25 in each of its first two years. Under the terms of the Agreement, these losses are allocated entirely to Lloyd. Requirements 1. Does the allocation of losses to Lloyd have economic effect within the meaning of the regulations under section 704(b)? Case Study: Deadwood Limited Partnership Facts WB Hickock Inc. and Cal Jane Inc. have owned equal interests in the capital and profits of Deadwood L.P. (“Deadwood”) since 2001. Assume Deadwood’s limited partnership agreement satisfies the safe harbor for economic effect. WB Hickock Inc. has a $200,000 capital loss carryforward that will expire in 2006. Consequently, WB Hickock suggests that the limited partnership agreement be amended to provide that in 2006, the first $200,000 of the partnership’s capital gains will be allocated to WB Hickock, with any remaining capital gains allocated equally between WB Hickock and Cal Jane. In 2007, the first $200,000 of Deadwood’s capital gains will be allocated to Cal Jane, with any remaining income allocated equally between WB Hickock and Cal Jane. These special allocations will be effective for both book and tax purposes. Requirements 1. Assume that Deadwood has had consistent capital gains since its formation, generating on average $225,000 of capital gains annually. Will the special allocations for 2006 and 2007 be allowed for tax purposes? 2. Now assume that Deadwood’s annual income varies considerably each year. For example, in 2004 the venture generated capital gains of $125,000, but in 2005 there were only $110,000 in capital losses. Based on this change in the facts , will the special allocations be allowed for tax purposes? Case Study: Tribeca Partnership Facts Two individuals, Duane and Reade (the “Partners”), formed Tribeca General Partnership. Duane and Reade each contributed $1,000 to Tribeca and also agreed that each would be allocated a 50-percent share of all partnership items. The partnership agreement provides that, upon the contribution of additional capital by either partner, Tribeca must revalue the partnership’s property and adjust the partners’ capital accounts under §1.704- 1(b)(2)(iv)(f). Tribeca borrowed $8,000 from a bank and used the borrowed and contributed funds to purchase an unimproved tract of land called Battery Park for $10,000. The loan was nonrecourse to the partners and was secured solely by Battery Park. No principal payments were due for 6 years, and the interest was payable semi-annually at a valid market rate. After one year, the value of Battery Park fell from $10,000 to $6,000, but the principal amount of the loan remained at $8,000. As part of a workout arrangement among the bank, Tribeca, Duane, and Reade, the bank reduced the principal amount of the loan by $2,000, and Duane contributed an additional $500 to Tribeca. Duane’s capital was immediately credited with the $500, which Tribeca used to pay currently deductible expenses incurred in connection with the workout. All $500 of the currently deductible workout expenses were allocated to Duane. Reade made no additional contributions to capital. At the time of the workout, Reade was insolvent within the meaning of §108(a). The Partners agreed that, after the workout, Duane would have a 60-percent interest and Reade would have a 40-percent interest. As a result of Battery Park’s decline in value and the workout, Tribeca had two items to allocate between the Partners. First, the agreement to cancel $2,000 of the loan resulted in $2,000 of COD income. Second, Duane’s contribution of $500 to Tribeca was an event that required Tribeca, under the partnership agreement, to revalue partnership property and adjust A’s and B’s capital accounts. The revaluation resulted in a $4,000 economic loss that must be allocated between the Partners’ capital accounts. Under the terms of the original partnership agreement, Tribeca would have allocated the items listed above equally between the Partners. The Partners, however, amended the agreement (in a timely manner) to make two special allocations. First, Tribeca allocated the entire $2,000 of COD income to Reade, an insolvent partner. Second, Tribeca specially allocates the book loss from the revaluation $1,000 to Duane and $3,000 to Reade. While Duane receives a $1,000 allocation of book loss and Reade receives a $3,000 allocation of book loss neither of these allocations results in a tax loss to either partner. Rather, the allocations result only in adjustments to the Partners’ capital accounts. Thus, the cumulative effect of the special allocations is to reduce each partner’s capital account to zero. Requirements Do Tribeca’s allocations lack substantiality under §1.704-1(b)(2)(iii) when the partners amend the partnership agreement to create offsetting special allocations of particular items after the events giving rise to the items have occurred? Case Study: Superior Paper Limited Partnership Facts Superior Paper’s operating agreement provides that taxable income or loss will be allocated 10% to the general partner and 90% to the limited partner. The partnership agreement (the “Agreement”) requires capital account maintenance in accordance with Treas. Reg. § 1.704-1(b)(2)(iv), and liquidation in accordance with positive capital account balances. The agreement contains both a qualified income offset and a minimum gain chargeback requirement. On January 1, 2006, Superior Paper had the following balance sheet. Tax/book Basis Operating assets $ 120,000 Real property: Cost $400,000 Acc. depr. (220,000) 180,000 $300,000 Nonrecourse mortgage on real property $ 170,000 Capital: General partner 122,000 Limited partner 8,000 $300,000 In 2006, Superior Paper made a $10,000 principal payment to reduce the mortgage to $160,000. The partnership’s 2006 tax loss was $30,000 ($10,000 operating income $40,000 depreciation deduction on the real property). Requirements Determine how the $30,000 loss should be allocated between the general and the limited partner, and prepare a year-end balance sheet reflecting the allocation.
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