Bryan and Cody each contributed $120,000 to the newly formed BC Partnership in exchange for a 50% interest. The partnership used the available funds to acquire equipment costing $200,000 and to fund current operating expenses. The partnership agreement provides that depreciation will be allocated 80% to Bryan and 20% to Cody.
Bryan and Cody each contributed $120,000 to the newly formed BC
Upon liquidation of the partnership, property will be distributed to the partners in accordance with their § 704(b) book capital account balances. Any partner with a negative capital account must contribute cash in the amount of the negative balance to restore the capital account to $0.
In its first year, the partnership reported an ordinary loss (before depreciation) of $80,000 and depreciation expense of $36,000. In its second year, the partnership reported $40,000 of income from operations (before depreciation), and it reported depreciation expense of $57,600.
a. Calculate the partners’ bases in their partnership interests at the end of the first and second tax years. Are any losses suspended? Explain.
b. Does the allocation provided in the partnership agreement have economic effect? Explain.
c. Now assume that on the first day of the third tax year, the partnership sells the equipment for $150,000. The gain on the sale is allocated equally to the partners. The partnership distributes all cash in accordance with the partners’ capital account balances, and the partnership liquidates. How will partnership cash balances be distributed to the partners upon liquidation? (Hint: First, calculate the partners’ bases in their partnership interests after reflecting any gain or loss on disposal of the equipment. Disregard any depreciation in year 3.) What observations can you make regarding the value of a deduction to each partner?
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