How do we form partnership and partner basis?

Formation

• Contributions
  • No gain/loss is recognized on a contribution of property to a partnership
• Partnership Interest
  • Capital Interest
  • Profit Interest
  • Schedule K-1 (Form 1065) below

• Service Provided
  • Non-taxable
  • Exception (taxable) when capital interest acquired for service provided

Example (Service Provided – Exception, taxable) A taxpayer receives a 30% partnership capital interest in exchange for service provided. On the day she is admitted to the partnership, the partnership’s assets have a basis of $30,000 and a liquidation value of $90,000.

Solution The taxpayer will recognize ordinary income of $27,000 (30% of $90,000).

Basis

• Outside basis
  • Basis that a partner has in the ownership interest in the partnership
• Inside basis
  • Basis that a partnership has in the assets that it owns.
• Partner Basis (outside basis)
  • + Cash contributed
  • + Property contributed (adjusted basis)
  • + Service provided (fair market value)
  • – Liability transferred to partnership, assumed by other partners
  • + Partner’s share of partnership liabilities
  • = Initial Basis in partnership (gain if liability is greater than basis)

Example (Outside basis) A and B form the AB Partnership. A contributes cash of $40,000 and B contributes land with a fair market value of $52,000, basis of $28,000 and a liability attached to the land of $12,000.

Solution +40,000 Cash + 6,000 Share of debt =46,000 A’s Basis ——————————————— +28,000 Basis in land -12,000 (Relief of liability) + 6,000 Increase in liability =22,000 B’s Basis

• Allocation of Partnership
  • Schedule K-1 (Form 1065)

• Recourse Debts
  • Personal liability which means that the creditor can go after the partner’s assets
  • It only applies to general partner, not limited partner
• Nonrecourse Debts
  • No personal liability
    • Nonrecourse secured debt (general)
      • Not included in at-risk basis
    • Qualified nonrecourse financing
      • Included in at-risk basis
      • Mortgage loan from unrelated lender

Example (Recourse and Nonrecourse debts) AB Partnership has two equal partners, General partner A and Limited partner B. AB partnership takes out $200,000 loan.

Solution If recourse loan, $200,000 is allocated to Partner A and increase his basis. No allocation to partner B. If nonrecourse loan, $200,000 is allocated between the two partners to $100,000 each.