Income Tax Fundamentals 2009 Gerald E. Whittenburg Martha Altus- Buller Student’s Copy

1. Chapter 10Partnership Taxation Income Tax Fundamentals 2009 Gerald E. Whittenburg Martha Altus-Buller Student’s Copy 2009 Cengage Learning

2. What is a Partnership? • A partnership is a syndicate, group, pool, joint venture or other unincorporated organization • Through which any business, financial operation or venture is carried on • Simply co-owning property does not constitute a partnership • Many co-owners of real estate choose to operate as a limited partnership or LLC 2009 Cengage Learning

3. Partnership Formation • When forming a partnership • Individuals contribute assets to partnership in exchange for a partnership interest • No gain/loss is recognized unless • Services are performed in exchange for partnership interest • Property is contributed with liabilities in excess of basis, then Recognized Gain = Liabilities Allocable to Others – Adjusted Basis of Property Contributed 2009 Cengage Learning

4. Partnership Formation • Partner’s basis in partnership interest Cash contributed plus: Basis of property transferred plus: Gain recognized less: Liabilities allocable to other partners equals: Initial basis 2009 Cengage Learning

5. Beginning Basis + Additional Contributions + Share of Taxable Income + Share of Capital Gains/Other Income - Distributions of Property or $ - Share of Net Loss from Operations* - Share of Capital Losses/Other Deductions +/- Increase/Decrease in Liabilities Basis in Partnership Interest (can’t drop below $0) *Can’t take basis below 0 and must comply with at-risk limitations Partner’s Basis in Partnership Interest (Subsequent Activities) 2009 Cengage Learning

6. Partnership Income Reporting • Partnerships do not pay tax • All information flows through to be reported by the partners • Return is due by 15th of 4th month following close of partnership tax year • Must report all elements of income and expense separately on Form 1065 (Partnership Tax Return) • Schedule K-1 takes total partnership income/expenses and allocates each item to each partner based upon their ownership percentage • Ordinary income/loss • Special income/deduction items 2009 Cengage Learning

7. Current Distributions & Guaranteed Payments • Partnerships may make distributions of money or other property to partners • ‘Current distribution’ does not completely terminate partner’s interest • No gain recognized by partner, unless partner’s basis in partnership has reached zero • Then only portion of current distribution in excess of basis is taxable 2009 Cengage Learning

8. At-Risk Limitations • Partners cannot deduct losses from activities in excess of their investment in those activities • Definitions • A “nonrecourse liability” is a debt for which the borrower is not personally liable • “Encumbered property” is the property pledged for a liability • Taxpayers are at-risk for an amount equal to: Cash and property contributed to partnership + Liabilities on encumbered properties (recourse debt) + Liabilities for which taxpayer is personally liable (recourse debt) + Retained profits in activity 2009 Cengage Learning

9. Real Estate & At-Risk Rules • Real estate acquired before 1987 is not subject to at-risk rules • For real estate acquired after 1986, the “qualified nonrecourse financing” is considered to be the amount at risk • Defined as debt secured by real estate and borrowed from person who regularly engages in the lending of money 2009 Cengage Learning

10. Limited Liability Companies (LLCs) • LLCs are a cross between a partnership and a corporation • Treated generally as a partnership for tax purposes • Each owner has limited liability • Advantages • Taxable income/loss passes through to owners • There is no general partner requirement • Owners in LLCs can participate in management • Owners have limited liability • LLC ownership interest is not a security • Tax attributes pass through to owners • LLCs offer greater tax flexibility than S corporations • Disadvantages • Because of newness, limited amount of case law dealing with LLCs • States are not uniform in treatment of LLCs 2009 Cengage Learning