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Partnerships, Real Estate, and Selected Basis Issues
Bill Johnson, CPA, ABV
Jeff Olson, CPA
Babush, Neiman, Kornman & Johnson, LLP
www.bnkj.com
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A Universal Given????
Cost = Basis
or, to say it another way,
Basis = Cost Is either just what was paid? What is “cost basis”?
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What’s the Big Deal About Basis?????Transaction economics and tax accounting may differ! Why?Transactions negotiated on fair valueTax accounting may record them at something other than negotiated value
Carry over cost basis (as in 1031 exchanges with deferred gain) But, not always
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What’s the Big Deal About Basis?????
It effects reported gain Who reports it How much
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What is Cost?
Seems simple, but that depends: Whose cost?
The partner’s or the partnership’s Inside basis/outside basis
Depending on which you mean, then you have to determine
Is it reflected, or not, on the partnership’s books/tax records?
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Partnership Basis Topics IRC Code Sections 721/704
and 754Only an overview It is very complex
What gives rise to these complicated tax accounting rules?
Can tax basis presentations ever have any useful meaning if they are not always based on the value/economics of a deal?
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Problem Cause #1A Partner’s contribution of
property to, or distributions
from, a partnership generally do
not trigger a recognizable tax
event - Section 721 This is generally a good thing - deferred
recognition of appreciation gains It just screws up the tax accounting relative to
the “deal” economics
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Basic Example - No Issues
Example 1: 50/50 partnership:
Partners contribute cash to buy assets-partnership cost -2,000Partnship develops, leases sells-sales proceeds 3,000
Gain 1,000
Distributions per partner 1,500Less what they put in (1,000)
Gain per partner 500
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Basic Example - 721 Issue
Example 2: 50/50 partnership, $500 carryover basis:
Partner 1 contributes appreciated land - value = $1,000 (500)Partner 2 contributes cash for improvements (1,000)Partnship develops, leases sells-sales proceeds 3,000
Gain 1,500
Distributions per partner 1,500Less what they put in at value (1,000)
Gain per partner 500
Whoops, that is a total gain of only 1,000Extra gain???? Does partner 2 report any? 500
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Basic Example - 721 IssueComparative balance sheets: Exple. 1 Exple. 2
Straight tax basisReal estate 2,000 1,500
Capital Partner 1 1,000 500Capital Partner 2 1,000 1,000
Total capital 2,000 1,500
Improved presentationReal estate 2,000 1,500704(c) asset 500
Total assets 2,000 2,000
Capital Partner 1 1,000 500Capital Partner 2 1,000 1,000704(c) equity-deferred gain to Partner 1 500
Total capital 1,000 2,000
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Assets Subject to Debt
Other potential complications What if the asset is not sold, but
held for rental and depreciated? What if only part of the project is
sold in a tax year?● What cost is being depreciated?● How is it allocated among the partners?
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Complex Example - 721 Issue
Example 3: 50/50 partnership, but contributed assets subject to debt :3-A
Land contributed - carry over basis 500704(c) asset 500Improvements funded with Partner 2 capital 1,000
Total assets 2,000
Assumed debt 750Partner 1 capital-carryover basis (land less debt assumed) (250)Partner 2 capital 1,000704(c) equity 500
Total equity 2,000
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Assets Subject to Debt
Contributions of assets subject to debt can trigger recognizable gain to the contributing partner
But limited to the proportion of the debt shifted to other partners Up to the debt in excess of his basis in the contributed asset
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Assets Subject to Debt
Example 3: 50/50 partnership, but contributed assets subject to debt :Debt
Calculation of gain recognition 100% ShiftedDebt relieved/assumed 750 375Contributor basis in assets (500) (250)
Excess (negative contribution/recognized gain) 250 125
Gain recognized by contributing partner increases his basis in the assetand decreases his deferred gain---Section 754 election.
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Complex Example - 721 Issue
Example 3: 50/50 partnership, but contributed assets subject to debt :3-A 3-B
Land contributed - carry over basis + gain recognized 500 625704(c) asset 500 375Improvements funded with Partner 2 capital 1,000 1,000
Total assets 2,000 2,000
Assumed debt 750 750Partner 1 capital-carryover basis (land less debt assumed) (250) (125)Partner 2 capital 1,000 1,000704(c) equity 500 375
Total equity 2,000 2,000
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The Problem Cause #2
Transactions betweenpartners may give rise toaccounting on thepartnership’s books:
Home Depot example Partnerships are different!
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Example 754 IssueSale of partnership interest
Assets are adjusted upward (stepped up) to account for the value paid by the new partner
The purchase value of a new partner’s interest is “pushed down” to the partnership
Partner’s capital account at the date of contribution equals his purchase price
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Example 754 Issue
Example 4: 50/50 partnership, sale of partnership interest:Old New
Assets 2,000 2,250
Partner 1 capital 1,000 1,000Partner 2 capital 1,000 0New partner 3 capital - 754 election 0 1,250
Total capital 2,000 2,250
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Section 754 Effects
Acquiring partner’s stepped up basis gives appropriately larger depreciation deductions to that partner
Upon sale, increased basis reduces gain recognizable to that partner
Former partners are unaffected Only a proportionate step up --- not to
100% of asset values as in 704(c)
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Contribution of Development Fees
Contribution of services, immediate capital account credit (capital interest)● equals immediate taxable income---
ordinary
Distribution priority (future profits interest)● No immediate tax event● If partnership gains are capital, then some
of the “services” treated as capital gain