Chapter 11

True/False Indicate whether the statement is true or false. ____ ____ 1. A property distribution from a partnership to a partner is generally taxable to the partner. 2. For Federal income tax purposes, a distribution from a partnership to a partner is treated the same as a distribution from a C corporation to its shareholders. 3. In a liquidating distribution, a partnership need not distribute all of its property to all of its partners. 4. A distribution cannot be proportionate if only one partner receives assets from the partnership. 5. For income tax purposes, proportionate and disproportionate distributions from a partnership are treated similarly. 6. Generally, gain is recognized on a proportionate current or liquidating distribution if the fair market value of property distributed exceeds the partners basis in the partnership interest. 7. In a proportionate nonliquidating distribution of cash and a capital asset, the partner recognizes gain to the extent the amount of cash distributed exceeds the partners basis in the partnership interest. 8. In a proportionate nonliquidating distribution, cash is deemed to be distributed first, followed by unrealized receivables and inventory and, last, capital and other assets. 9. For purposes of determining gain on a current distribution to a partner, a distribution of cash includes relief of a partners share of partnership liabilities and certain distributions of marketable securities.

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____ 10. The LMO Partnership distributed $30,000 cash to Emma in a proportionate, nonliquidating distribution. Emmas basis in her partnership interest was $25,000 immediately before the distribution. As a result of the distribution, Emmas basis is reduced to $0 and she recognizes a $5,000 gain. ____ 11. Jared owns a 40% interest in the capital and profits of the JAJ Partnership. Immediately before he receives a proportionate nonliquidating distribution from JAJ, the basis of his partnership interest is $60,000. The distribution consists of $40,000 in cash and land with a fair market value of $25,000. JAJs adjusted basis in the land immediately before the distribution is $30,000. As a result of the distribution, Jared recognizes no gain or loss and his basis in the land is $20,000. ____ 12. Jeremy receives a proportionate nonliquidating distribution from the JKL Partnership when the basis of his interest is $100,000. The distribution consists of cash of $25,000, land with a basis of $30,000 and a fair market value of $65,000, and inventory with a partnership basis of $50,000 and fair market value of $60,000. As a result of this distribution, Jeremy recognizes a $50,000 gain and takes a $65,000 basis in the land and a $60,000 basis in the inventory.

____ 13. Shelby, a partner in the STU partnership, received a proportionate nonliquidating distribution of $50,000 cash, unrealized receivables with a basis of $0 and a fair market value of $40,000, and land with a basis of $35,000 and a fair market value of $25,000. Her basis in the partnership interest immediately before the distributions was $70,000. She will recognize $0 gain on the distribution, and her basis in the receivables and land will be $0 and $20,000 respectively. ____ 14. Matt, a partner in the MB Partnership, receives a proportionate, nonliquidating distribution of property having a fair market value of $16,000 and a partnership basis of $23,000. Matts basis in the partnership is $10,000 before the distribution. In this situation, Matt will recognize a $6,000 gain, take a $16,000 basis in the property, and his basis in the partnership interest is reduced to zero. ____ 15. Tim and Darby are equal partners in the TD Partnership. Partnership income for the year is $60,000. Tim needs cash in order to pay tax on his share of the partnership income, but Darby wants to leave the cash in the partnership for expansion. If the partners agree, it is acceptable for TD to distribute $8,000 to Tim, and no cash or other property to Darby. ____ 16. Marcie is a 40% member of the M&A LLC. Her basis is $40,000 immediately before the LLC distributes to her $30,000 of cash and land (basis to the LLC of $20,000 and fair market value of $25,000). As a result of the proportionate, nonliquidating distribution, Marcie recognizes a gain of $15,000 and her basis in the land equals its fair market value of $25,000. ____ 17. Pat is a 40% member of the P&J LLC. Her basis is $30,000 immediately before the LLC distributes to her $40,000 of cash and land (basis to the partnership of $25,000 and fair market value of $50,000). As a result of the proportionate nonliquidating distribution, Pat recognizes a gain of $10,000 and her basis in the land is $0. ____ 18. In a proportionate liquidating distribution, RST Partnership distributes to partner Riley cash of $30,000, accounts receivable (basis of $0 and fair market value of $40,000), and land (basis of $65,000 and fair market value of $50,000). Rileys basis was $40,000 before the distribution. On the liquidation, Riley recognizes a gain of $0, and her basis is $10,000 in the land and $0 in the accounts receivable. ____ 19. In a proportionate liquidating distribution, UVW Partnership distributes to partner William cash of $25,000, accounts receivable (basis of $10,000 and fair market value of $8,000), and land (basis of $50,000 and fair market value of $60,000). Williams basis was $75,000 before the distribution. On the liquidation, William recognizes no gain or loss, and he takes a basis of $10,000 in the accounts receivable, and $50,000 in the land. ____ 20. Zachs partnership interest basis is $80,000. Zach receives a proportionate, liquidating distribution from a liquidating partnership of $60,000 cash and inventory having a basis of $30,000 to the partnership and a fair market value of $26,000. Zach assigns a basis of $20,000 to the inventory and recognizes no gain or loss. ____ 21. Carlos receives a proportionate liquidating distribution consisting of $8,000 cash and inventory with a basis to the partnership of $5,000 and a fair market value of $6,000. His basis in his partnership interest was $15,000 immediately before the distribution. Carlos assigns a basis of $5,000 to the inventory, and recognizes a $2,000 capital loss. ____ 22. In a proportionate liquidating distribution in which the partnership is also liquidated, Macy received cash of $10,000 and inventory (basis of $18,000 and fair market value of $32,000). Immediately before the distribution, Macys basis in the partnership interest was $40,000. Macy recognizes no gain or loss, and her basis in the inventory is $30,000.

____ 23. In a proportionate liquidating distribution in which the partnership is also liquidated, Ralph received cash of $30,000, accounts receivable (basis of $0 and fair market value of $20,000), and a desk (basis of $0 and fair market value of $1,000). Immediately before the distribution, Ralphs basis in the partnership interest was $40,000. Ralph realizes and recognizes a loss of $10,000, and his basis is $0 in both the accounts receivable and the desk. ____ 24. Several years ago, the Jaymo Partnership purchased 2,000 shares of ABCO stock (publicly traded) for $40,000; the stock now has a fair market value of $90,000. If this stock is distributed to Jason in liquidation of his 30% partnership interest, it is treated as a cash distribution of $75,000 and a property distribution of $15,000. ____ 25. Normally a distribution of property from a partnership does not result in gain recognition. However, a distribution of marketable securities may be treated, in part, as a distribution of cash that could result in gain recognition. ____ 26. Mike contributed property to the MDB Partnership in 2008. At the time of the contribution, the basis in the property was $30,000 and its value was $55,000. In 2011, MDB distributed that property to partner Dana. Because distributions from a partnership to a partner are generally nontaxable, neither Mike nor Dana should recognize any gain on the distribution. ____ 27. A disproportionate distribution arises when the partnership distributes a share of partnership hot assets to one or more partners that is not the same as the partners ownership interest in the partnership. ____ 28. A disproportionate distribution occurs when a cash distribution is not made in proportion to the partners ownership interests in the partnership. (Assume the partnerships only assets are cash and land held for investment). ____ 29. A payment to a retiring general partner for his or her share of goodwill of a partnership in which capital is not a material income-producing factor is classified as a 736(a) income payment and results in ordinary income to the retiring partner and a current deduction to the partnership, if the goodwill payment is not provided for in the partnership agreement. ____ 30. The Crimson Partnership is a service provider. Its assets consist of unrealized receivables (basis $0, value $200,000), cash of $200,000, and land (basis of $280,000, value of $400,000). Assume 25% general partner Jill has a basis in her partnership interest of $130,000. If the ongoing partnership distributes the $200,000 cash to Jill in liquidation of her interest in the partnership, she will recognize ordinary income of $50,000 and a capital gain of $20,000. ____ 31. Tylers basis in his partnership interest is $110,000, including his share of partnership debt. Sarah buys Tylers partnership interest for $60,000 cash and she assumes Tylers $90,000 share of the partnerships debt. If the partnership owns no hot assets, Tyler will recognize a capital loss of $50,000. ____ 32. Beth sells her 25% partnership interest to Katie for $50,000 cash on July 1 of the current tax year. Katie also assumed Beths share of the partnerships liabilities. Beths basis in her partnership interest at the beginning of the year was $40,000, including a $15,000 share of partnership liabilities. The partnerships income for the entire year was $100,000, and Beths share of partnership debt was $10,000 as of the date she sold the partnership interest. Assume the partnership has no hot assets and that its income is earned evenly throughout the year. Beth recognizes a gain of $12,500 on the sale.

____ 33. Nick sells his 25% interest in the LMNO Partnership to new partner Katrina for $57,500. The partnerships assets consist of cash ($100,000), land (basis of $90,000; fair market value of $70,000), and inventory (basis of $40,000; fair market value of $60,000). Nicks basis in his partnership interest was $57,500. On the sale, Nick will recognize ordinary income of $5,000 and a capital loss of $5,000. ____ 34. A partnership has accounts receivable with a basis of $0 and a fair market value of $20,000 and depreciation recapture potential of $30,000. All other assets of the partnership are either cash, capital assets, or 1231 assets. If a purchaser acquires a 40% interest in the partnership from another partner, the selling partner will be required to recognize ordinary income of $20,000. ____ 35. If a partnership incorporates, it is always deemed to first distribute all of its assets and liabilities to the partners in complete liquidation. Then the partners are deemed to contribute those assets to the new corporation (with the corporation assuming the related liabilities) in a transaction that qualifies under 351. ____ 36. In the year a donor gives a partnership interest to a donee, their share of the partnerships income is prorated between the donor and donee. ____ 37. A partnership is required to make a downward adjustment to the basis of its assets if a partnership interest is sold and if the total decline in value of partnership assets is more than $250,000. ____ 38. A 754 election is made for a tax year in which the partner recognizes gain or loss on a distribution from the partnership or the basis in distributed property is increased or decreased from the inside basis the partnership held in those assets. The election is made by a partner any time it is necessary to adjust his or her share of the inside basis of partnership assets. ____ 39. The MBA Partnership makes a 736(b) cash payment of $20,000 to partner Amanda in liquidation of her interest in the partnership. The partnership owns no hot assets. Amandas basis in her partnership interest before the distribution was $50,000. If the partnership has a 754 election in effect, it will record a $30,000 decrease in its inside basis in partnership assets, affecting all the remaining partners in the partnership. ____ 40. Jeremy sold his 40% interest in the HIJ Partnership to Ashley for $400,000. The inside basis of all partnership assets was $600,000 at the time of the sale. If the partnership makes a 754 election, it will record a $160,000 step-up in the basis of the partnership assets, and the step-up will be attributed solely to Ashley. ____ 41. A partnership continues in existence unless one of the following happens: 1) all assets are distributed to the partners in liquidation of the partnership, or 2) one partner buys the interest of the second partner in a two partner partnership (resulting in a single owner of the entity). ____ 42. Kyle gifts a 40% interest in his consulting business to his daughter Amy. For the current tax year, the KA Partnership reports income of $100,000. Kyles services to the partnership were valued at $40,000. For the current tax year, Amy would report a $24,000 share of the partnerships income. ____ 43. Rex and Scott operate a law practice in partnership form. Because Rex and Scott are brothers, the partnership is subject to the family partnership income reallocation rules. ____ 44. A limited liability company generally provides limited liability for those owners that are not active in the management of the LLC but requires owner-managers of the LLC to have unlimited personal liability for LLC debts.

Multiple Choice Identify the choice that best completes the statement or answers the question. ____ 1. Stephanie receives a proportionate nonliquidating distribution from the QRS Partnership. The distribution consists of $60,000 cash and property with an adjusted basis to the partnership of $30,000 and a fair market value of $25,000. Immediately before the distribution, Stephanies adjusted basis for her partnership interest is $80,000. Stephanies basis in the noncash property received is: a. $15,000. b. $20,000. c. $25,000. d. $30,000. e. None of the above. 2. At the beginning of the year, Elsies basis in the E&G Partnership interest is $60,000. She receives a proportionate nonliquidating distribution from the partnership consisting of $10,000 of cash, unrealized accounts receivable (basis of $0, fair market value $30,000), and inventory (basis of $10,000, fair market value of $20,000). After the distribution, Elsies bases in the accounts receivable, inventory, and partnership interest are: a. $0; $10,000; and $40,000. b. $0; $20,000; and $30,000. c. $30,000; $10,000; and $10,000. d. $30,000; $20,000; and $0. e. None of the above. 3. Megans basis was $100,000 in the MAR Partnership interest just before she received a proportionate nonliquidating distribution consisting of land held for investment (basis of $80,000, fair market value of $100,000) and inventory (basis of $60,000, fair market value of $60,000). After the distribution, Megans bases in the land and inventory are, respectively: a. $80,000 and $20,000. b. $100,000 and $0. c. $40,000 and $60,000. d. $50,000 and $50,000. e. None of the above. 4. Matt receives a proportionate nonliquidating distribution. At the beginning of the partnership year, the basis of his partnership interest is $60,000. During the year, he received a cash distribution of $25,000 and a property distribution (basis of $20,000 and fair market value of $12,000). In addition, Matts share of partnership liabilities was reduced by $20,000 during the year. How much gain or loss does Matt recognize; what is his basis in the property he received; and what is his remaining basis in the partnership interest? a. $3,000 loss; $12,000 basis in property; $0 remaining basis. b. $0 gain or loss; $15,000 basis in property; $0 remaining basis. c. $0 gain or loss; $20,000 basis in property; $15,000 remaining basis. d. $0 gain or loss; $12,000 basis in property; $23,000 remaining basis. e. $5,000 gain; $20,000 basis in property; $0 remaining basis. 5. Martin has a basis in a partnership interest of $100,000. At the end of the current year, the partnership distributed to Martin, in a proportionate nonliquidating distribution, cash of $10,000, inventory (basis to the partnership of $6,000 and fair market value of $12,000), and land (basis to the partnership of $20,000 and fair market value of $15,000). In addition, Martins share of partnership debt decreased by $10,000 during the year. What basis does Martin take in the inventory and land and in the partnership interest following the distribution? a. $6,000 basis in inventory; $15,000 basis in land, $59,000 basis in partnership.

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b. c. d. e. ____

$6,000 basis in inventory; $20,000 basis in land, $54,000 basis in partnership. $12,000 basis in inventory; $15,000 basis in land, $53,000 basis in partnership. $12,000 basis in inventory; $20,000 basis in land, $53,000 basis in partnership. $12,000 basis in inventory; $20,000 basis in land, $48,000 basis in partnership.

6. Andrew receives a proportionate nonliquidating distribution from the AEF Partnership. The distribution consists of $50,000 cash and property (adjusted basis to the partnership of $34,000 and fair market value of $42,000). Immediately before the distribution, Andrews adjusted basis in the partnership interest was $40,000. His basis in the noncash property received is: a. $0. b. $34,000. c. $42,000. d. $50,000. e. None of the above. 7. Aaron owns a 30% interest in a continuing partnership. The partnership distributes a $35,000 year-end cash bonus to all the partners. In a proportionate nonliquidating distribution, the partnership also distributed property (basis of $15,000; fair market value of $20,000) to Aaron. Immediately before the distribution, Aarons basis in the partnership interest was $50,000. As a result of the distribution, Aaron recognizes: a. No gain or loss. b. Ordinary loss of $5,000. c. Capital loss of $5,000. d. Ordinary gain of $5,000. e. Capital gain of $5,000. 8. Eric receives a proportionate nonliquidating distribution when the basis of his partnership interest is $80,000. The distribution consists of $20,000 in cash and property with an adjusted basis to the partnership of $45,000 and a fair market value of $40,000. Erics basis in the noncash property and his remaining basis in the partnership interest are: a. $45,000; $35,000. b. $45,000; $15,000. c. $40,000; $40,000. d. $40,000; $20,000. e. None of the above. 9. Martha receives a proportionate nonliquidating distribution when the basis of her partnership interest is $50,000. The distribution consists of $60,000 cash and noninventory property (adjusted basis to the partnership of $20,000; fair market value of $23,000). How much gain or loss does Martha recognize, and what is her basis in the distributed property and in her partnership interest following the distribution? a. $0 gain or loss; $20,000 basis in property; $0 basis in partnership interest. b. $0 gain or loss; $23,000 basis in property; $2,000 basis in partnership interest. c. $10,000 capital gain; $0 basis in property; $0 basis in partnership interest. d. $10,000 capital gain; $20,000 basis in property; $0 basis in partnership interest. e. $10,000 ordinary income; $0 basis in property; $10,000 basis in partnership interest.

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____ 10. Nicoles basis in her partnership interest was $160,000, including her $50,000 share of partnership liabilities. The partnership decides to liquidate, and after repaying all liabilities, distributes all remaining assets proportionately to the partners. Nicole receives $30,000 cash and accounts receivable with a $50,000 basis and a $52,000 fair market value to the partnership. What gain or loss does Nicole recognize, and what is her basis in the accounts receivable? a. $80,000 loss; $50,000 basis. b. $30,000 loss; $50,000 basis.

c. $28,000 loss; $52,000 basis. d. $78,000 loss; $52,000 basis. e. $0 loss; $80,000 basis. ____ 11. Anthonys basis in the WAM Partnership interest was $200,000 just before he received a proportionate liquidating distribution consisting of investment land (basis of $90,000, fair market value $100,000), and inventory (basis of $30,000, fair market value $70,000). After the distribution, Anthonys recognized gain or loss and his basis in the land and inventory are: a. $80,000 loss; $90,000 (land); $30,000 (inventory). b. $70,000 loss; $100,000 (land); $30,000 (inventory). c. $30,000 loss; $100,000 (land); $70,000 (inventory). d. $0 gain or loss; $170,000 (land); $30,000 (inventory). e. None of the above. ____ 12. Beth has an outside basis of $60,000 in the BBDE Partnership as of December 31 of the current year. On that date the partnership liquidates and distributes to Beth a proportionate distribution of $20,000 cash and inventory with an inside basis to the partnership of $18,000 and a fair market value of $22,000. In addition, Beth receives a desk (not inventory) which has an inside basis and fair market value of $200 and $350, respectively. None of the distribution is for partnership goodwill. How much gain or loss will Beth recognize on the distribution, and what basis will she take in the desk? a. $21,800 loss; $200 basis. b. $21,650 loss; $350 basis. c. $0 loss; $200 basis. d. $0 loss; $22,000 basis. e. None of the above. ____ 13. Landon received $50,000 cash and a capital asset (basis of $70,000 and fair market value of $80,000) in a proportionate liquidating distribution. His basis in his partnership interest was $100,000 prior to the distribution. How much gain or loss does Landon recognize and what is his basis in the asset received? a. $0 gain or loss; $70,000 basis. b. $0 gain or loss; $50,000 basis. c. $20,000 gain; $70,000 basis. d. $30,000 gain; $70,000 basis. e. $30,000 gain; $80,000 basis. ____ 14. Jonathon owns a one-third interest in a liquidating partnership. Immediately before the liquidation, Jonathons basis in the partnership interest is $60,000. The partnership distributes cash of $32,000 and two parcels of land (each with a fair market value of $10,000). Parcel A has a basis of $2,000 to the partnership and Parcel B has a basis of $6,000. Jonathons basis in the two parcels of land is: a. Parcel A, $2,000; Parcel B, $6,000. b. Parcel A, $7,000; Parcel B, $21,000. c. Parcel A, $10,000; Parcel B, $10,000. d. Parcel A, $14,000; Parcel B, $14,000. e. Parcel A, $15,000; Parcel B, $45,000. ____ 15. Michelle receives a proportionate liquidating distribution when the basis of her partnership interest is $50,000. The distribution consists of $58,000 cash and noninventory property (adjusted basis to the partnership of $10,000 and fair market value of $12,000). The partnership has no hot assets. How much gain or loss does Michelle recognize, and what is her basis in the distributed property? a. $0 gain or loss; $0 basis in property. b. $0 gain or loss; $50,000 basis in property. c. $8,000 ordinary income; $0 basis in property.

d. $8,000 capital gain; $10,000 basis in property. e. $8,000 capital gain; $0 basis in property. ____ 16. Jamie owns a 40% interest in the JSD LLC. In liquidation of the entity, Jamie receives a proportionate distribution of $20,000 cash, inventory (basis of $12,000 and fair market value of $14,000), and land (basis of $10,000 and fair market value of $30,000). Jamies basis in the entity immediately before the distribution was $50,000. As a result of the distribution, what is Jamies basis in the inventory and land, and how much gain or loss does she recognize? a. $0 basis in inventory; $30,000 basis in land; $0 gain or loss. b. $12,000 basis in inventory; $18,000 basis in land; $0 gain or loss. c. $12,000 basis in inventory; $10,000 basis in land; $8,000 loss. d. $14,000 basis in inventory; $30,000 basis in land; $14,000 gain. e. $30,000 basis in inventory; $0 basis in land; $0 gain or loss. ____ 17. In a proportionate liquidating distribution, Scott receives a distribution of $20,000 cash, accounts receivable (basis of $0 and fair market value of $40,000), and land (basis of $30,000 and fair market value of $60,000). In addition, the partnership repays all liabilities, of which Scotts share was $20,000. Scotts basis in the entity immediately before the distribution was $100,000. As a result of the distribution, what is Scotts basis in the accounts receivable and land, and how much gain or loss does he recognize? a. $0 basis in accounts receivable; $30,000 basis in land; $0 gain or loss. b. $0 basis in accounts receivable; $60,000 basis in land; $0 gain or loss. c. $40,000 basis in accounts receivable; $30,000 basis in land; $0 gain or loss. d. $40,000 basis in accounts receivable; $60,000 basis in land; $20,000 gain. e. $0 basis in accounts receivable; $80,000 basis in land; $20,000 loss. ____ 18. In a proportionate liquidating distribution, Alexandria receives a distribution of $70,000 cash, accounts receivable (basis of $0 and fair market value of $20,000), and land (basis of $30,000 and fair market value of $60,000). In addition, the partnership repays all liabilities, of which Alexandrias share was $40,000. Alexandrias basis in the entity immediately before the distribution was $90,000. As a result of the distribution, what is Alexandrias basis in the accounts receivable and land, and how much gain or loss does she recognize? a. $0 basis in accounts receivable; $0 basis in land; $20,000 gain. b. $0 basis in accounts receivable; $30,000 basis in land; $0 gain or loss. c. $0 basis in accounts receivable; $0 basis in land; $0 gain or loss. d. $0 basis in accounts receivable; $30,000 basis in land; $0 gain. e. $20,000 basis in accounts receivable; $0 basis in land; $20,000 gain. ____ 19. In a proportionate liquidating distribution, Lina receives a distribution of $10,000 cash, accounts receivable (basis of $0 and fair market value of $12,000), and inventory (basis of $30,000 and fair market value of $40,000). Linas basis in the entity immediately before the distribution was $80,000. As a result of the distribution, what is Linas basis in the accounts receivable and inventory, and how much gain or loss does she recognize? a. $0 basis in accounts receivable; $30,000 basis in inventory; $40,000 loss. b. $0 basis in accounts receivable; $70,000 basis in inventory; $0 gain or loss. c. $0 basis in accounts receivable; $40,000 basis in inventory; $50,000 loss. d. $12,000 basis in accounts receivable; $30,000 basis in inventory; $28,000 gain. e. $12,000 basis in accounts receivable; $40,000 basis in inventory; $18,000 gain. ____ 20. Which of the following statements correctly reflects the rules regarding proportionate liquidating distributions? a. Relief of liabilities is treated as a distribution of cash but only to the extent that the cash distribution does not exceed the partners basis in the partnership interest.

b. A partners basis in distributed unrealized receivables is the lesser of the partnerships basis in the receivables or their fair market value. c. The basis of unrealized receivables cannot be stepped up to their fair market value unless the partner has adequate unabsorbed basis. d. Assets are deemed distributed in the following order: cash, unrealized receivables and inventory and finally, capital assets. e. The partner can recognize gain, but not loss, on a proportionate liquidating distribution. ____ 21. Which of the following distributions would never result in gain recognition to the recipient partner? a. A distribution of cash that follows a contribution of appreciated property to the partnership. b. A distribution of a slightly appreciated marketable security. c. A distribution of property to a partner who, three years ago, contributed other property with a built-in gain. d. A distribution to a second partner of property contributed by the first partner two years ago. e. A proportionate distribution of inventory property. ____ 22. Last year, Darby contributed land (basis of $60,000 and fair market value of $80,000) to the Seagull LLC in exchange for a 25% interest in the LLC. In the current year, the LLC distributes the land (now worth $82,000) to Shelby, who is also a 25% owner. Immediately prior to the distribution, Darbys basis in the LLC was $70,000, while Shelbys basis in the LLC was $110,000. How much gain or loss must be recognized and by whom? What is Shelbys basis in the property she receives and Darbys basis in her partnership interest following the distribution? a. No gain or loss; Shelbys basis in the property is $80,000; Darbys basis in interest is $70,000. b. $20,000 gain recognized by Darby; Shelbys basis in the property is $80,000; Darbys basis in interest is $90,000. c. $22,000 gain recognized by Darby; Shelbys basis in the property is $82,000; Darbys basis in interest is $92,000. d. $20,000 gain recognized by Shelby; Shelbys basis in the property is $80,000; Darbys basis in interest is $90,000. e. $22,000 gain recognized by Shelby; Shelbys basis in the property is $82,000; Darbys basis in interest is $92,000. ____ 23. Last year, Jose contributed nondepreciable property with a basis of $35,000 and a fair market value of $45,000 to the Starling Partnership in exchange for a 25% interest in the partnership. In the current year, he receives a nonliquidating distribution from the partnership of other property with a basis to the partnership of $28,000 and a fair market value of $36,000. The basis in his partnership interest at the time of the distribution was $30,000. How much gain or loss does Jose recognize on the distribution? (Assume no other distributions have been made to Jose, the property he originally contributed is still owned by the partnership, and this is not a disguised sale transaction.) a. $0 gain or loss. b. $2,000 loss. c. $6,000 gain. d. $8,000 gain. e. $10,000 gain. ____ 24. Which of the following is not typically considered to be a hot asset? a. Accounts receivable of a cash basis partnership. b. Inventory with a basis of $16,000 and a fair market value of $15,000. c. Depreciation recapture potential.

d. Land held for development. e. All of the above are typically considered to be hot assets. ____ 25. Tom and Terry are equal owners in the Tatum LLC, a cash basis service entity. Tatum has unrealized receivables of $400,000 (basis of $0), and no other hot assets. Goodwill is provided for in the LLCs operating agreement. If Tatum distributes cash of $500,000 to Tom in liquidation of his LLC interest, which of the following statements is incorrect? a. This is a disproportionate distribution with respect to hot assets. b. Any portion of the payment that relates to LLC goodwill can be deducted by the LLC as a 736(a) payment. c. The payment for Toms share of the LLCs investment real estate is a 736(b) payment. d. Any 736(a) payment will result in ordinary income to Tom. e. Any 736(b) payment will be treated as a payment in exchange for Toms LLC interest. ____ 26. The December 31, 2011, balance sheet of the RST General Partnership reads as follows. Basis $ 65,000 0 55,000 $120,000 $ 40,000 40,000 40,000 $120,000 FMV $ 65,000 7,500 100,000 $172,500 $ 57,500 57,500 57,500 $172,500

Cash Receivables Capital and 1231 assets Total Roy, capital Sue, capital Ted, capital Total

The partners share equally in partnership capital, income, gain, loss, deduction and credit. Teds adjusted basis for his partnership interest is $40,000. On December 31, 2011, he retires from the partnership, receiving a $60,000 cash payment in liquidation of his interest. The partnership agreement states that $2,500 of the payment is for goodwill. Which of the following statements about this distribution is false? a. If capital is NOT a material income-producing factor to the partnership, the 736(a) payment will be $2,500. b. If capital IS a material income-producing factor, the entire $60,000 payment will be a 736(b) property payment. c. The payment for Teds share of goodwill will create $2,500 of ordinary income to him. d. The partnership can deduct any amount that is a 736(a) payment because it will be determined without regard to partnership profits. e. All statements are false. ____ 27. Which of the following statements is true regarding the sale of a partnership interest? a. The selling partners share of partnership liabilities is disregarded in determining the gain or loss on the sale of a partnership interest. b. For purposes of computing the selling partners gain or loss, the partners basis in the partnership interest is determined as of the last day of the partnership tax year ending before the year in which the interest is sold. c. No reporting is required if a partner sells an interest in a partnership. d. The selling partner could be required to report both ordinary income and a capital loss on sale of the partnership interest. e. The partners share of partnership hot assets is disregarded in determining the character of the partners gain on the sale of the partnership interest.

____ 28. Nicholas is a 25% owner in the DDBN LLC (a calendar year entity). At the end of the last tax year, Nicholass basis in his interest was $50,000, including his $20,000 share of LLC liabilities. On July 1 of the current tax year, Nicholas sells his LLC interest to Anna for $80,000 cash. In addition, Anna assumes Nicholass share of LLC liabilities, which, at that date, was $15,000. During the current tax year, DDBNs taxable income is $120,000 (earned evenly during the year). Nicholass share of the LLCs unrealized receivables is valued at $6,000 ($0 basis). At the sale date, what is Nicholass basis in his LLC interest, how much gain or loss must he recognize, and what is the character of the gain or loss? a. $45,000 basis; $6,000 ordinary income; $44,000 capital gain. b. $60,000 basis; $6,000 ordinary income; $29,000 capital gain. c. $60,000 basis; $35,000 capital gain. d. $75,000 basis; $0 ordinary income; $20,000 capital gain. e. $75,000 basis; $6,000 ordinary income; $14,000 capital gain. ____ 29. James, Justin, and Joseph are equal partners in the JJJ Partnership. The partnership balance sheet reads as follows on December 31 of the current year: Basis $ 60,000 0 75,000 $135,000 $ 45,000 45,000 45,000 $135,000 FMV $ 60,000 45,000 90,000 $195,000 $ 65,000 65,000 65,000 $195,000

Cash Unrealized receivables Land Total James, capital Justin, capital Joseph, capital Total

Partner Joseph has an adjusted basis of $45,000 for his partnership interest. If Joseph sells his entire partnership interest to new partner Kayla for $65,000 cash, how much capital gain and ordinary income must Joseph recognize from the sale? a. $20,000 ordinary income. b. $20,000 capital gain. c. $15,000 ordinary income; $5,000 capital gain. d. $45,000 ordinary income; $25,000 capital loss. e. None of the above. ____ 30. Tina sells her 1/3 interest in the TAX Partnership to James for $60,000 cash plus the assumption of Tinas $4,000 share of partnership debt. On the sale date, the partnership balance sheet and agreed-upon fair market values were as follows: Basis FMV Cash $30,000 $ 30,000 Receivables 0 42,000 Land 60,000 120,000 Total $90,000 $192,000 Notes payable Tina, capital Ariel, capital Xena, capital Total $12,000 26,000 26,000 26,000 $90,000 $ 12,000 60,000 60,000 60,000 $192,000

As a result of the sale, Tina recognizes: a. No gain or loss. b. $34,000 capital gain. c. $38,000 capital gain. d. $14,000 ordinary income and $20,000 capital gain. e. $14,000 capital gain and $24,000 ordinary income. ____ 31. Which of the following statements about the transfer of a partnership interest is not true? a. The sellers adjusted basis for the partnership interest is increased by the sellers share of undistributed partnership income (or reduced by partnership loss) for the portion of the partnerships taxable year ending on the date of the sale. b. The partnership taxable year generally does not close with respect to a partner who transfers a partnership interest at death. c. The amount realized on the sale of a partnership interest is the sum of any money and the fair market value of any property received for the interest, plus the selling partners share of partnership liabilities under 752. d. With respect to a transfer of a partnership interest by gift, all partnership gain, loss, credit, etc., items are allocated between the donor and the donee. e. All of the above are true statements. ____ 32. Brittany, Jennifer, and Daniel are equal partners in the BJD Partnership. The partnership balance sheet reads as follows on December 31 of the current year. Basis $ 75,000 0 45,000 $120,000 $ 40,000 40,000 40,000 $120,000 FMV $ 75,000 51,000 63,000 $189,000 $ 63,000 63,000 63,000 $189,000

Cash Unrealized receivables Land Total Brittany, capital Jennifer, capital Daniel, capital Total

Partner Daniel has an adjusted basis of $40,000 for his partnership interest. If Daniel sells his entire partnership interest to new partner Amber for $73,000 cash, how much can the partnership step-up the basis of Ambers share of partnership assets under 754 and 743(b)? a. $6,000. b. $18,000. c. $23,000. d. $33,000. e. None of the above. ____ 33. Partner Jordan received a distribution of $80,000 cash from the JKL Partnership in complete liquidation of his partnership interest. If Jordans outside basis immediately before the distribution was $90,000, and if the partnership has made (and not revoked) a 754 election in a prior year, which of the following statements is true? (Assume the partnership owns no hot assets.) a. The partnership will step-down the basis of its assets by $10,000. b. The partnership will step-up the basis of its assets by $10,000. c. Jordan will recognize $10,000 of ordinary loss on the distribution. d. Jordan will recognize a $10,000 capital loss on the distribution.

e. Both a. and d. are true. ____ 34. The RST Partnership makes a proportionate distribution of its assets to Ryan, in complete liquidation of his partnership interest. The distribution consists of $40,000 in cash and capital assets with a basis to the partnership of $30,000 and a fair market value of $48,000. None of the payment is for partnership goodwill. At the time of the distribution, Ryans partnership basis is $45,000 and the partnership has no liabilities and no hot assets. If the partnership makes an optional basis adjustment election on a timely filed return, it recognizes: a. Capital gain of $25,000 and increases the basis of its remaining assets by $12,500. b. Capital loss of $5,000 and decreases the basis of its remaining assets by $5,000. c. No gain or loss and increases the basis of its remaining assets by $25,000. d. No gain or loss and decreases the basis of its remaining assets by $58,000. e. None of the above. ____ 35. Cynthia sells her 1/3 interest in the CAR Partnership to Brandon for $80,000 cash. Brandon also assumed Cynthias 1/3 share of partnership liabilities. On the date of sale, the partnership balance sheet and agreed upon fair market values were as follows: Basis FMV Cash $ 55,000 $ 55,000 Receivables 0 60,000 Land 50,000 125,000 Total $105,000 $240,000 Recourse liabilities Cynthia, capital Arnold, capital Ralph, capital Total $ 15,000 30,000 30,000 30,000 $105,000 $ 15,000 75,000 75,000 75,000 $240,000

If the partnership has a 754 election in effect, the total step-up in basis that Brandon can take in the partnership assets is: a. $85,000. b. $55,000. c. $50,000. d. $45,000. e. $20,000. ____ 36. A partnership may make an optional election to adjust the basis of its property on a distribution to a partner which liquidates the partners entire interest in the partnership. If such an election is in effect, the partnership: a. Generally applies the election to transfers that take place at any later date, unless the election is revoked. b. Only adjusts the basis of its property for differences in basis between that of the partnership and a distributee partner if a transferor-transferee situation arises within two years after the distribution. c. Increases the basis of similar retained assets when a distributee partner takes a basis which is greater than the partnerships basis in these assets, assuming the partnership does not have any receivables or inventory. d. Decreases the basis of similar retained assets when a distributee partner takes a basis for the distributed assets which is less than the partnerships basis in these assets. e. All of the above. ____ 37. Which of the following transactions will not result in termination of a partnership for Federal tax purposes?

a. b. c. d.

The partnership is incorporated. A 70% interest in partnership capital and profits is sold to a third party purchaser. Cash is distributed in liquidation of a 60% partners interest in a five-partner partnership. A 40% interest in partnership capital and profits is sold to the other partner in a twopartner partnership. e. None of the above. ____ 38. On December 31 of last year, Rachel gave her daughter, Courtney, a gift of a 25% interest in a partnership in which capital is a material income-producing factor. For the current calendar year, the partnerships ordinary income was $200,000. Rachel and Courtney were the only partners, and there were no guaranteed payments. Rachels services performed for the partnership were worth $40,000, and Courtney has never performed any services. What is Courtneys distributive share of partnership income for the current year? a. $100,000. b. $80,000. c. $50,000. d. $40,000. e. None of the above. ____ 39. Which of the following statements, if any, about an LLC is false? a. An LLC is usually taxed like a partnership. b. Members of an LLC generally have limited personal liability for debts of the LLC, except for the managing member who has unlimited liability for LLC debts. c. Members of an LLC can participate in management of the LLC unless the member agrees not to participate. d. An LLC can specially allocate income items, as long as the substantial economic effect rules of 704(b) are followed. e. None of the above statements is false. ____ 40. Which of the following is not true regarding a limited liability company? a. The Code does not specifically provide for the taxation of limited liability companies. Therefore, an LLC that is taxed as a partnership must rely primarily on the tax provisions that apply to partnerships. b. An LLC is effectively treated as a limited partnership with no limited partners. c. An LLC offers several advantages over the S corporation, including not making the managing member of the LLC liable for self-employment taxes on his or her share of LLC income. d. In general, an LLC member is not personally liable for LLC debts. e. Any member of an LLC can participate in the management of the LLC if the operating agreement so permits. Matching Match the following statements with the best match from the choices below. Note: Choice L may be used more than once. a. Terminates the partners interest in the partnership. b. Ordinary income-producing items. c. An unrealized receivable. d. Cash, then inventory and unrealized receivables, then other assets. e. Cash basis accounts receivable, for example. f. Fair market value exceeds 120% of basis. g. Inside basis of partnership property can be adjusted to reflect the purchase price paid.

h. i. j. k. l. ____ ____ ____ ____ ____ ____ ____ ____ ____

Changes the partners or the partnerships ordinary income potential. Any partnership assets other than cash, capital, or 1231 assets. Does not eliminate the partners interest in the partnership. A distribution of all partnership hot assets. No correct match provided.

1. Nonliquidating distribution 2. Recaptured receivables 3. Inventory 4. Unrealized receivable 5. Depreciation recapture 6. Disproportionate distribution 7. Liquidating distribution 8. Nonqualified distribution 9. Ordering rules

____ 10. Hot assets ____ 11. Substantially appreciated inventory ____ 12. Optional adjustment election Match the following statements with the best match from the choices below. Note: Choice M may be used more than once. a. Includes the partners share of partnership liabilities. b. Could result from sale of a partnership interest for less than the partners share of the inside basis of assets. c. Liquidation payments from this type of partnership are always 736(b) payments. d. Could arise if a distribution results in gain to the distributee partner. e. May be a 736(a) payment. f. May receive 736(a) payments. g. Sale of more than 50% in less than 12 months. h. Liquidation payments from this type of partnership may include 736(a) payments. i. A 736(b) payment. j. Adjustment designed to bring inside and outside bases into balance. k. Partnership asset basis is at least $250,000 > FMV. l. Would result if the partner contributes appreciated property to the partnership. m. No correct match is provided. ____ 13. Unstated goodwill ____ 14. Stated goodwill ____ 15. Capital intensive partnership ____ 16. Service providing partnership ____ 17. Sales price of partnership interest

____ 18. Limited partner ____ 19. General partner ____ 20. Section 754 ____ 21. Mandatory step down ____ 22. Step up ____ 23. Step down ____ 24. Limited liability partnership ____ 25. Technical termination Match the following independent distribution payments in liquidation of a partners interest in an ongoing partnership with the statements below. a. A payment for the partners share of partnership income under 736(a). b. A payment for the partners share of partnership property under 736(b). c. The payment includes both a 736(a) and a 736(b) element. ____ 26. Payment to a limited partner for $10,000 of goodwill, where goodwill is not provided for in the partnership agreement. ____ 27. Payment to a general partner for $10,000 of goodwill, where goodwill is provided for in the partnership agreement, and the partnership derives most of its income from services. ____ 28. Payment of $25,000 cash for a partners share of substantially appreciated inventory. ____ 29. Payment of $60,000 cash for a partners share of unrealized receivables where the partner is a general partner, and most of the partnerships income is derived from services. ____ 30. Payment of $60,000 cash for a partners share of unrealized receivables where the partner is a limited partner, and most of the partnerships income is derived from services. ____ 31. Payment of an annuity to a retiring general partner in a service oriented partnership of 5% of partnership profits each year for the five years following the partners retirement. ____ 32. Payment of $100,000 cash, representing the partners share of the value of partnership equipment which has a potential depreciation recapture of $25,000. Match the following independent descriptions as hot (i.e., ordinary income) or nonhot assets with the statements below. a. Hot assets for purposes of distributions, liquidation of a partnership interest under 736, and sale of a partnership interest. b. May be a hot asset for some but not all the purposes stated in (a). c. Not a hot asset. ____ 33. Inventory with a basis of $10,000 and a fair market value of $15,000. ____ 34. Marketable securities (not held as inventory). ____ 35. Cash basis accounts receivable. ____ 36. Installment receivables for sale of a capital asset.

____ 37. Land held by the partnership for the purpose of subdividing and selling lots. ____ 38. Inventory with a basis of $10,000 and a fair market value of $10,500. Problem 1. Chelsea owns a 25% capital and profits interest in the calendar-year CJDV Partnership. Her adjusted basis for her partnership interest on July 1 of the current year is $170,000. On that date, she receives a proportionate nonliquidating distribution of the following assets: Partnerships Basis in Asset $ 90,000 110,000 100,000 Assets Fair Market Value $ 90,000 140,000 160,000

Cash Inventory Land (held for investment) a. b. c. d.

Calculate Chelseas recognized gain or loss on the distribution, if any. Calculate Chelseas basis in the inventory received. Calculate Chelseas basis in land received. The land is a capital asset. Calculate Chelseas basis for her partnership interest after the distribution.

2. Melissa is a partner in a continuing partnership. At the end of the current year, the partnership makes a proportionate, nonliquidating distribution to Melissa of $50,000 cash, inventory (basis of $22,000, fair market value of $20,000), and land (basis of $30,000, fair market value of $60,000). Melissas basis in the partnership interest was $90,000 before the distribution. What is Melissas basis in the inventory, land, and partnership interest following the distribution? 3. In a proportionate liquidating distribution in which the partnership is liquidated, Greg received cash of $20,000, inventory (basis of $2,000, fair market value of $3,000), and a capital asset (basis and fair market value of $4,000). Immediately before the distribution, Gregs basis in the partnership interest was $30,000. a. b. How much gain or loss will Greg recognize on the distribution? What is Gregs basis in the inventory and the capital asset?

4. The JIH Partnership distributed the following assets to partner James in a proportionate liquidating distribution in which the partnership is liquidated: $25,000 cash, land parcel A (basis of $5,000, fair market value of $30,000), and land parcel B (basis of $5,000, fair market value of $15,000). Jamess basis in his partnership interest was $85,000 immediately before the distribution. a. b. How much gain or loss will James recognize on the distribution? What basis will James allocate to parcel A and parcel B?

5. Josh has a 25% capital and profits interest in the calendar-year GDJ Partnership. His adjusted basis for his partnership interest on October 15 of the current year is $300,000. On that date, the partnership liquidates and makes a proportionate distribution of the following assets to Josh.

Cash Inventory a. b.

Partnerships Basis in Asset $ 70,000 120,000

Assets Fair Market Value $ 70,000 150,000

Calculate Joshs recognized gain or loss on the liquidating distribution, if any. How would your answer to a. change if the partnership also distributed a small parcel of land it had held for investment to Josh? Assume the land has a $5,000 adjusted basis (FMV is $8,000) to the partnership.

6. The December 31, 2011, balance sheet of the BCD General Partnership reads as follows. Basis $210,000 0 42,000 $252,000 $ 84,000 84,000 84,000 $252,000 FMV $210,000 120,000 69,000 $399,000 $133,000 133,000 133,000 $399,000

Cash Receivables Capital assets Total Ben, capital Christina, capital Danielle, capital Total

Each partner shares in 1/3 of the partnership capital, income, gain, loss, deduction and credit. Capital is not a material income-producing factor to the partnership. On December 31, 2011, general partner Christina receives a distribution of $140,000 cash in liquidation of her partnership interest under 736. Nothing is stated in the partnership agreement about goodwill. Christinas outside basis for the partnership interest immediately before the distribution is $84,000. How much is Christinas recognized gain from the distribution and what is the character of the gain? 7. The December 31, 2011, balance sheet of the DBW General Partnership is as follows: Basis $240,000 0 90,000 $330,000 $110,000 110,000 110,000 $330,000 FMV $240,000 75,000 150,000 $465,000 $155,000 155,000 155,000 $465,000

Cash Receivables Capital assets Total Dana, capital Brooke, capital Whitney, capital Total

The partners share equally in partnership capital, income, gain, loss, deduction, and credit and capital is not a material income-producing factor. On December 31, 2011, general partner Dana receives a distribution of $155,000 cash in liquidation of her interest under 736. Danas outside basis for the partnership interest immediately before the distribution is $110,000. What is Danas gain or loss on the distribution and its character?

8. Susan is a one-fourth limited partner in the SJ Partnership in which capital is not a material income-producing factor. Partnership assets consist of land (fair market value of $100,000, basis of $80,000), accounts receivable (fair market value of $100,000, basis of $0) and cash of $200,000. SJ distributes $100,000 of the cash to Susan in liquidation of her interest. Susans basis in the partnership interest was $70,000 immediately before the distribution. How much gain or loss does Susan recognize and what is its character? How much can the partnership deduct? 9. On August 31 of the current tax year, the balance sheet of the RBD General Partnership is as follows: Basis $150,000 0 600,000 $750,000 $150,000 200,000 200,000 200,000 $750,000 FMV $150,000 90,000 660,000 $900,000 $150,000 250,000 250,000 250,000 $900,000

Cash Receivables Capital assets Total Nonrecourse debt Rachel, capital Barry, capital Dale, capital Total

On that date, Rachel sells her one-third partnership interest to Lisa for $300,000, including cash and relief of Rachels share of the nonrecourse debt. The nonrecourse debt is shared equally among the partners. Rachels outside basis for her partnership interest is $250,000. How much capital gain and/or ordinary income will Rachel recognize on the sale? 10. Hannah sells her 25% interest in the HIJK Partnership to Alyssa for $120,000 cash. At the end of the year prior to the sale, Hannahs basis in HIJK was $70,000. The partnership allocates $15,000 of income to Hannah for the portion of the year she was a partner. On the date of the sale, the partnership assets and the agreed fair market values were as follows. Basis $100,000 0 240,000 $340,000 FMV $100,000 80,000 220,000 $400,000

Cash Accounts Receivable Land Total

Determine the amount and character of any gain that Hannah recognizes on the sale. 11. The December 31, 2011, balance sheet of the calendar-year JKL Partnership reads as follows. Basis $24,000 33,000 $57,000 $19,000 19,000 19,000 FMV $ 24,000 105,000 $129,000 $ 43,000 43,000 43,000

Cash Capital asset (nondepreciable) Total Jan, capital Ken, capital Laura, capital

Total

$57,000

$129,000

Each partner shares in 1/3 of the partnership capital, income, gain, loss, deduction and credit. On December 31, 2011, Jan sells her 1/3 partnership interest to Jennifer for $43,000 cash. Assume the partnership makes a 754 election for 2010. a. b. What is the amount of Jennifers step-up adjustment under 743(b)? If the nondepreciable capital asset is sold the next year for $120,000, determine the amount of gain that Jennifer will recognize on her tax return because of the sale.

Essay 1. Cindy, a 20% general partner in the CDE Partnership, wants to retire and has approached the other partners about having the partnership buy her out. The partnership is a cash basis, service oriented partnership in which Cindy is an active partner. The partnership assets consist primarily of unrealized receivables and cash. The partnership also has substantial going concern value (goodwill) which is probably its most valuable asset. The other partners in the partnership are also active in the business and are not related to Cindy. Discuss from Cindys viewpoint how you would structure the liquidation of her interest under 736. Answer as if you are her advocate. Do you think the other partners will agree with this structure? If not, what structure would they prefer? 2. Your client has operated a sole proprietorship for several years, and is now interested in raising capital for expansion. He is considering forming either a C corporation or an LLC. a. Describe the treatment of an LLC and discuss any advantages the LLC offers over the C corporation. Assume instead the client has previously operated as a C corporation. Describe the tax consequences of converting to an LLC.

b.

Chapter 11 Answer Section

TRUE/FALSE 1. ANS: F A distribution from a partnership to a partner is typically a tax-deferred transaction. The distribution reduces the partners basis in the partnership interest and the partner takes a carryover or substituted basis in properties received. PTS: 1 DIF: 1 REF: p. 11-2 | p. 11-3 OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 2. ANS: F A distribution from a partnership to a partner is a tax-deferred transaction which results in no current taxable income. A distribution from a C corporation to its shareholders is taxed as a dividend to the extent of the corporations earnings and profits (E & P). PTS: 1 DIF: 1 REF: p. 11-2 OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 3. ANS: T A liquidating distribution occurs either when 1) the partnership liquidates and terminates the interests of all the partners, or 2) an ongoing partnership distributes property in liquidation of a single partners interest. PTS: 1 DIF: 1 REF: p. 11-3 OBJ: 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 4. ANS: F A disproportionate distribution arises when the partners share of ordinary income-producing assets increases or decreases as the result of a distribution. There are situations in which a distribution can be made to only one partner without upsetting this balance. For example, the partnership might not own any hot assets or the partnership might liquidate the interest of that partner by distributing the partners share of hot and non-hot assets (without making corresponding distributions to the other partners). In either of these situations, each partner is still responsible for the ordinary income potential inherent in his/her/its share of partnership assets, and so the distribution is considered to be proportionate. PTS: 1 DIF: 1 REF: p. 11-4 OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 5. ANS: F An effect of the aggregate theory is that each partner is ultimately responsible for tax related to the ordinary income potential of that partners share of partnership assets. In a proportionate distribution, each partners share of ordinary income potential is preserved, so no special tax treatment is needed. In a disproportionate distribution, the partners shares of ordinary income potential are changed as a result of the distribution. Transactions are deemed to occur to correct that balance and taxable income is reported as a result of these deemed balancing transactions. PTS: 1 DIF: 1 REF: p. 11-4 OBJ: 4 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 6. ANS: F If property is distributed from a partnership, the partner generally recognizes no gain on the distribution.

PTS: 1 DIF: 1 REF: p. 11-6 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 7. ANS: T In a proportionate distribution of cash and property, the partner does not recognize a gain or loss unless the amount of cash distributed exceeds the partners outside basis. The property takes the lesser of a carryover basis (the partnerships basis in the property) or a substituted basis (the partners basis in the partnership interest after cash and ordinary income-producing property distributions are taken into account). PTS: 1 DIF: 1 REF: p. 11-5 | p. 11-6 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 8. ANS: T In a proportionate distribution of property, cash is distributed first, followed by unrealized receivables and inventory. All other assets are distributed last. PTS: 1 DIF: 1 REF: p. 11-6 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 9. ANS: T Either a distribution of cash (including certain marketable securities treated as cash) or relief of debt will trigger gain to the distributee partner if the distribution exceeds the partners basis in interest. If other property is distributed, and the partnerships inside basis in the assets exceeds the partners outside basis, the partner generally takes a substituted basis in the property. PTS: 1 DIF: 1 REF: Example 5 | Example 6 OBJ: 1 | 3 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 10. ANS: T A distribution of $25,000 cash reduces Emmas basis to $0. The additional $5,000 cash distribution creates a $5,000 gain for her. PTS: 1 DIF: 1 REF: Example 5 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 11. ANS: T Under 731(a) gain is recognized by a distributee partner in a nonliquidating distribution only if the cash received (including marketable securities or liability relief treated as cash) exceeds the basis of the partners interest. Because Jared received cash of only $40,000, no gain results. Jareds basis in the land is limited to $20,000, and his interest basis is reduced to zero. PTS: 1 DIF: 1 REF: Example 5 | Example 8 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 12. ANS: F Jeremy recognizes no gain or loss on the distribution. His basis in the land is a $30,000 carryover basis. His basis in the inventory is limited to the $45,000 basis remaining after taking into account the $25,000 cash distribution and the $30,000 land distribution. In a proportionate nonliquidating distribution, gain is recognized to the extent the distributed cash exceeds the partners basis in the partnership interest. The basis in noncash property is the lesser of the partnerships inside basis in the property or the partners outside basis before the distribution.

PTS: 1 DIF: 1 REF: Example 8 | Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 13. ANS: T Shelby will take a carryover basis of $50,000 and $0, respectively, for the cash and unrealized receivables. The distribution of these assets will reduce her outside basis for her partnership interest to $20,000 ($70,000 $50,000 $0). She will take a $20,000 substituted basis for the land. PTS: 1 DIF: 1 REF: Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 14. ANS: F Section 732(a)(2) limits the basis of distributed property to the basis of the partners interest before the distribution, reduced by any cash distributed in the transaction, or $10,000. No gain or loss is recognized by either Matt or the partnership on the distribution. PTS: 1 DIF: 1 REF: Example 8 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 15. ANS: T Disproportionate distributions are permitted. To ensure equity to all partners, though, capital accounts must be maintained in accordance with 704(b) and (c). In addition, the distribution cannot be a disguised sale. PTS: 1 DIF: 1 REF: p. 11-3 | p. 11-4 | p. 11-12 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 16. ANS: F A partner recognizes a gain on receipt of a proportionate nonliquidating distribution only when the distributed cash exceeds the partners basis in the partnership interest before the distribution. Any other distributed property takes the lesser of a carryover basis (partnerships basis in distributed property) or a substituted basis (partners remaining basis after cash distributions). Marcie recognizes no gain or loss and her basis in the land is $10,000. PTS: 1 DIF: 1 REF: Example 5 | Example 8 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 17. ANS: T A partner recognizes a gain on receipt of a proportionate nonliquidating distribution when the distributed cash exceeds the partners basis in the partnership interest before the distribution. Any other distributed property takes a substituted basis of $0. PTS: 1 DIF: 1 REF: Example 5 | Example 8 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 18. ANS: T A partner only recognizes a gain on receipt of a proportionate liquidating distribution when the distributed cash exceeds the partners basis in the partnership interest before the distribution. Rileys $40,000 basis is first reduced by the cash distribution to $10,000. The accounts receivable take a $0 carryover basis, and the remaining $10,000 basis is allocated to the land. PTS: 1 DIF: 1 REF: Example 12 NAT: AICPA FN-Measurement | AACSB Analytic OBJ: 2 MSC: 5 min

19. ANS: F Williams basis in the land is limited to his $40,000 basis in the partnership interest after the cash and accounts receivable distributions. Williams $75,000 basis is first reduced by the cash distribution to $50,000. Next, the accounts receivable take a $10,000 carryover basis and reduce Williams basis in the partnership interest to $40,000. The basis in the land is the lesser of Williams remaining $40,000 basis in his partnership interest or the partnerships $50,000 basis in the land. PTS: 1 DIF: 1 REF: Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 20. ANS: T Zachs basis is reduced to $20,000 by the cash distribution. Because $20,000 is less than the partnerships $30,000 basis in the inventory, the inventory takes a substituted basis of $20,000, and Zach recognizes no gain or loss. PTS: 1 DIF: 1 REF: p. 11-9 | Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 21. ANS: T The cash distribution reduces Carloss outside basis in his partnership interest to $7,000 ($15,000 $8,000). He will take a $5,000 substituted basis for the inventory and recognize a $2,000 capital loss. PTS: 1 DIF: 1 REF: p. 11-9 to 11-12 | Concept Summary 11.2 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 22. ANS: F Macys basis is reduced to $30,000 by the cash distribution. The basis in the inventory is limited to the partnerships $18,000 basis. Macy assigns a basis of $28,000 ($10,000 + $18,000) to the assets she received. Her remaining basis in the partnership interest is $12,000. Because she only received cash and hot assets in the liquidating distribution, she may recognize her realized loss of $12,000. PTS: 1 DIF: 2 REF: Example 14 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 23. ANS: F A loss can only be recognized in a liquidating distribution from a partnership if the only assets distributed are cash, unrealized receivables, and inventory. In this distribution, Ralph also received 1231 property, so the loss is not deductible. Ralphs basis is reduced to $10,000 by the cash distribution. The accounts receivable take a carryover basis of $0, and Ralphs remaining basis in the partnership interest of $10,000 is allocated to the desk. PTS: 1 DIF: 2 REF: Example 15 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 24. ANS: T The appreciation in the stock allocable to Jasons ownership interest is treated as a property distribution rather than a cash distribution. Jasons share of the appreciation in the stock before the distribution was $15,000 [30% ($90,000 $40,000)]. Jasons deemed cash distribution is $75,000 ($90,000 $15,000) and his property distribution is $15,000. PTS: 1 DIF: 2 REF: Example 16 NAT: AICPA FN-Measurement | AACSB Analytic 25. ANS: T OBJ: 3 MSC: 10 min

The fair market value of a marketable security distributed to a partner is generally treated as a cash distribution. On a distribution to a partner, gain arises when cash distributions (or deemed cash distributions) exceed the partners basis in the partnership interest. PTS: 1 DIF: 2 REF: Example 16 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 26. ANS: F A distribution of precontribution gain property results in gain to the contributing partner under 704(c)(1)(B) if it is distributed to a partner other than the contributing partner within seven years of the contribution and any precontribution gain remains to be recognized. PTS: 1 DIF: 1 REF: p. 11-14 | Example 18 OBJ: 3 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 27. ANS: T Each partner is deemed to own a share of the partnerships unrealized receivables and inventory. If a partners share of these assets changes, the partners ordinary income potential has shifted. Thus, a disproportionate distribution is one in which such ordinary income potential has shifted. PTS: 1 DIF: 1 REF: Example 21 OBJ: 4 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 28. ANS: F Each partner is deemed to own a share of the partnerships unrealized receivables and inventory. If a partners share of these assets changes, the partners ordinary income potential has shifted. A disproportionate distribution is one in which this ordinary income potential has shifted. A disproportionate distribution does not necessarily occur when a partner receives a disproportionate share of assets that does not cause this shift. PTS: 1 DIF: 1 REF: Example 21 OBJ: 4 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 29. ANS: T Goodwill is a 736(a) income payment only if the payment is to a retiring general partner, the partnership is an entity in which capital is not a material income-producing factor, and the goodwill is not provided for in the partnership agreement. PTS: 1 DIF: 1 REF: Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 30. ANS: T Section 736 applies to this transaction. Because capital is not a material income-producing factor in the partnership and because Jill is a general partner, the cash payment for her $50,000 share of the unrealized receivables is classified as a guaranteed payment under 736(a), and Jill will recognize $50,000 of ordinary income. The rest of the payment will be a 736(b) payment, and Jill will recognize $20,000 ($150,000 $130,000) of capital gain. PTS: OBJ: MSC: 31. ANS: 1 5 5 min F DIF: 2 REF: Example 22 to 27 | Concept Summary 11.3 NAT: AICPA FN-Measurement | AACSB Analytic

The partners share of partnership debt is included in both the partners basis in the partnership interest and in the proceeds received on the sale. Tylers sales price for the interest is $150,000 ($60,000 cash + $90,000 assumption of partnership debt). Because his basis was $110,000, he realizes a capital gain of $40,000. PTS: 1 DIF: 2 REF: Example 28 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 32. ANS: T Beths $40,000 basis is reduced by the $5,000 decrease in her share of partnership debt and is increased by her $12,500 share of partnership income for one-half of the tax year ($100,000 25% 1/2 year) to become $47,500. Thus, $60,000 (cash of $50,000 + $10,000 share of liabilities) $47,500 (adjusted basis) equals $12,500 gain on the sale. PTS: 1 DIF: 1 REF: Example 29 | Example 30 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 33. ANS: T Each partner is deemed to own a share of the partnerships unrealized receivables and inventory. If a partnership interest is sold, the partner is treated as selling the underlying share of the partnerships hot assets. Nick receives $15,000 for his share of the partnerships inventory, in which the partnerships basis is $10,000. Therefore, Nick recognizes $5,000 of ordinary income. The remaining sales price is for Nicks interest in the partnerships land and cash. Nick receives $42,500 ($57,500 $15,000) for his interest in those assets which have a basis of $47,500, so he recognizes a $5,000 capital loss on that part of the transaction. PTS: 1 DIF: 1 REF: Example 35 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 34. ANS: T The selling partner must recognize ordinary income to the extent of gain inherent in the partners share of unrealized receivables. The sellers 40% share of receivables and recapture is $20,000 [($20,000 + $30,000) 40%]. The partnership has no basis in these items, so ordinary income must be recognized for the entire $20,000. PTS: 1 DIF: 1 REF: p. 11-24 | p. 11-25 | Example 31 to 33 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 35. ANS: F A partnership or LLC can incorporate in one of three ways, including the liquidation scenario process described by the question. In another approach, the partnership may (directly) contribute its assets (subject to liabilities) to a new corporation in a 351 transaction, and then distribute the corporate stock to the partners in exchange for their partnership interests. As a third alternative, the partnership may contribute the partners interests in the partnership directly to the corporation in exchange for the stock in the new corporation. Each of the three methods may result in different inside and outside bases of the corporate assets and stocks. PTS: 1 DIF: 1 REF: p. 11-27 OBJ: 7 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 36. ANS: T Partnership income is prorated between the donor and donee for the year of the gift. If the partnerships tax year does not close on the date of the gift, the partnership is not required to issue a Schedule K-1 to the donor until its normal due date. PTS: 1 DIF: 1 REF: p. 11-28 OBJ: 7

NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 37. ANS: T If the basis of partnership assets exceeds their value by more than $250,000 and if there is a sale of a partnership interest or a distribution of partnership assets that results in a difference between inside and outside basis, the partnership has a substantial built-in loss. The partnership is not required to make a 754 election, but the basis of partnership assets must be reduced to correct the basis differential. PTS: 1 DIF: 1 REF: p. 11-29 OBJ: 7 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 38. ANS: F The partnership, not the partner, makes a basis adjustment election under 754. Once made, the election remains in effect until it is revoked. PTS: 1 DIF: 1 REF: p. 11-29 OBJ: 8 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 39. ANS: T A distribution in which the partner reports a loss results in a step-down in partnership asset basis under 754. As Amanda receives a distribution of $20,000 cash against a basis of $50,000, she reports a $30,000 loss. A step-down resulting from a distribution to a partner is allocated to the remaining assets in the partnership and affects the remaining partners. PTS: 1 DIF: 1 REF: Example 41 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 40. ANS: T The step-up related to the sale of the partnership interest is calculated as the difference between Ashleys purchase price for the partnership interest ($400,000) and her 40% share of the inside basis of partnership assets. The step-up is $160,000 ($400,000 $240,000) and is allowed solely to Ashley. PTS: 1 DIF: 1 REF: p. 11-29 | p. 11-30 | Example 39 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 41. ANS: F The partnership can also terminate if the partnership redeems the interest of all partners (or all except for one partner), or if there is a technical termination of the partnership. A technical termination occurs when there is a sale or exchange of 50% or more of the capital and profits interests of the partnership within a 12-month period. PTS: 1 DIF: 1 REF: Example 44 OBJ: 9 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 42. ANS: T In a family partnership where capital is not a material income-producing factor, the income cannot always be allocated proportionately based on ownership percentages. Instead, the value of the services performed must first be taken into account. Any remaining income is allocated according to ownership percentages. In this case, $40,000 of the partnerships income is first allocated to Kyle. The remaining $60,000 is allocated according to profit-sharing percentages, with $24,000 being assigned to Amy and $36,000 being assigned to Kyle. PTS: 1 DIF: 1 REF: Example 47 NAT: AICPA FN-Measurement | AACSB Analytic 43. ANS: F OBJ: 10 MSC: 2 min

For purposes of 704(e), a family does not include brothers or sisters. PTS: 1 DIF: 1 REF: p. 11-34 OBJ: 10 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 44. ANS: F A properly established limited liability company provides limited liability for all of its members, regardless of whether they are active in the management of the LLC. PTS: 1 OBJ: 11 MSC: 2 min MULTIPLE CHOICE 1. ANS: B Stephanies basis in the partnership interest is first reduced to $20,000 by the $60,000 cash distribution. Because this is a nonliquidating distribution, the basis in the noncash property is the lesser of $20,000 (remaining basis in the partnership interest) or the partnerships $30,000 basis in the property. The basis in the property, therefore, is $20,000, and Stephanies basis in the partnership interest is reduced to $0. PTS: 1 DIF: 1 REF: Example 8 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 2. ANS: A Elsies $60,000 basis is first reduced by the cash distribution of $10,000 to $50,000. The accounts receivable and inventory are distributed next and take carryover bases of $0 and $10,000, respectively. This reduces the basis in the partnership interest to $40,000. PTS: 1 DIF: 1 REF: Example 9 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 3. ANS: C Under the ordering rules for distributions, cash is distributed first, followed by unrealized receivables and inventory; other assets are distributed last. For Megan, the inventory is distributed first and takes a carryover basis of $60,000. This reduces Megans basis to $40,000. The land is distributed next and takes the $40,000 remaining basis. PTS: 1 DIF: 1 REF: Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 4. ANS: B Matts basis is first reduced by the $25,000 cash distribution and the $20,000 relief of liabilities (treated as a cash distribution). The property distributed takes the lesser of a carryover basis ($20,000) or Matts remaining basis in the partnership interest ($15,000); therefore, Matt has a $15,000 basis in the property he received and no remaining basis in the partnership interest. PTS: 1 DIF: 1 REF: Example 6 | Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 5. ANS: B Basis of Martins interest $100,000 Less: Cash and deemed cash distribution (20,000) Basis before property distributions $ 80,000 DIF: 1 REF: p. 11-35 | p. 11-36 NAT: AICPA FN-Measurement | AACSB Analytic

Less: Inventory distribution Less: Land distribution Basis after property distributions

(6,000)* (20,000)* $ 54,000

*Martins basis in the inventory and land equals the partnerships basis in these properties. Whether the property is appreciated or depreciated does not matter in this case, because his basis in these properties is not limited. PTS: 1 DIF: 1 REF: Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 6. ANS: A Andrews $40,000 basis in the partnership interest is first reduced by the $50,000 cash distribution. This results in Andrew recognizing a $10,000 gain and his outside basis is reduced to $0. As this is a nonliquidating distribution, the basis in the noncash property is the lesser of the $0 remaining basis in the partnership interest, or the partnerships $34,000 basis in the property. The basis in the property, then, is $0, and Andrews basis in the partnership interest is reduced to $0. PTS: 1 DIF: 1 REF: Example 5 | Example 8 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 7. ANS: A On a nonliquidating distribution, the partner generally does not recognize a gain and never recognizes a loss. Instead, the basis in the partnership interest is reduced by the cash received and by the partnerships basis in the property received. Aarons basis in his partnership interest immediately following the distribution is $0 ($50,000 $35,000 $15,000). PTS: 1 DIF: 1 REF: Example 4 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 8. ANS: B After reducing the basis of Erics partnership interest by the $20,000 cash received, his interest basis is $60,000 before considering the property distribution. The property takes the lesser of a substituted or carryover basis, or $45,000. Erics basis in the partnership interest is reduced to $15,000. PTS: 1 DIF: 1 REF: Example 8 | Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 9. ANS: C Because Martha received a cash distribution in excess of her basis in the partnership interest before the distribution, she must recognize a capital gain in the amount of that excess, or $10,000 ($60,000 distribution $50,000 basis before distribution). Her basis in the property she received is limited to the amount of the basis in the partnership interest following the cash distribution, or $0. Her basis in the partnership interest following all distributions remains $0. PTS: OBJ: MSC: 10. ANS: 1 1 5 min B DIF: 1 REF: Example 5 | Example 8 NAT: AICPA FN-Measurement | AACSB Analytic

The partnerships repayment of liabilities is treated as a cash distribution to Nicole of $50,000. Combined with the $30,000 cash actually distributed, Nicole is deemed to receive a cash distribution of $80,000. Her remaining basis is $80,000. Nicole cannot assign a basis in the accounts receivable of more than the partnerships basis; that basis is limited to $50,000. Because Nicole received no other assets, she may claim a capital loss of $30,000 for her remaining basis. PTS: 1 DIF: 2 REF: Example 6 | Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 11. ANS: D Under the ordering rules for distributions, cash is distributed first, followed by unrealized receivables and inventory; other assets are distributed last. For Anthony, the inventory is distributed first and takes a carryover basis of $30,000. This reduces Anthonys basis to $170,000. The land is distributed next. Because this is a liquidating distribution, the land absorbs Anthonys remaining basis in WAM of $170,000. Anthony cannot claim a loss because he has received property other than cash, inventory, and unrealized receivables. PTS: 1 DIF: 1 REF: Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 12. ANS: D The cash and inventory are distributed first and take bases of $20,000 and $18,000, respectively. The partner cannot recognize a loss on the distribution because the desk is a 1231 asset (depreciable property used in a trade or business). Only cash, inventory and receivables can be distributed if the partner is to recognize a loss. Therefore, the desk must take a substituted basis of $22,000 to the partner, which is the amount of the partners remaining outside basis when the desk is distributed. PTS: 1 DIF: 2 REF: Example 15 | Concept Summary 11.2 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 13. ANS: B Because Landon has received property other than cash and unrealized receivables or inventory, no loss may be recognized on the liquidating distribution. The capital asset will take a substituted basis of $50,000, which was Landons remaining basis in his partnership interest after the cash distribution is considered. PTS: 1 DIF: 1 REF: Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 14. ANS: D Jonathons $60,000 basis is first reduced by the $32,000 cash distribution. The remaining $28,000 basis is allocated to the land in a three-step process. First, the land parcels are allocated a carryover basis of $2,000 and $6,000 respectively. Next, the bases are increased to correspond to their fair market values of $10,000 each. The remaining basis of $8,000 is allocated to the two parcels in proportion to their respective fair market values. Because the values of the properties are equal, the additional $8,000 is divided equally, resulting in an ending basis of $14,000 ($10,000 + $4,000) for each property. PTS: 1 DIF: 1 REF: Example 13 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 15. ANS: E Michelles $50,000 basis is first reduced by the $58,000 cash distribution she receives, which results in an $8,000 capital gain (because the partnership has no hot assets). After this distribution, Michelles basis is $0. When the remaining partnership property is distributed, it also takes a $0 basis.

PTS: 1 DIF: 1 REF: Example 5 | Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 16. ANS: B Jamies basis in the LLC interest is first reduced by the $20,000 cash distribution to $30,000. Next, the inventory is distributed and takes a carryover basis of $12,000. The land takes the remaining basis of $18,000, and Jamie recognizes no gain or loss. PTS: 1 DIF: 1 REF: Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 17. ANS: B Scotts basis in the LLC interest is first reduced to $60,000 by the $20,000 cash distribution and the $20,000 repayment of liabilities (treated as a cash distribution). Next, the accounts receivable are distributed and take a carryover basis of $0. The land takes the remaining basis of $60,000, and Scott recognizes no gain or loss. PTS: 1 DIF: 1 REF: Example 6 | Example 9 | Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 18. ANS: A Alexandrias basis in the interest is first reduced by the $70,000 cash distribution and the $40,000 repayment of liabilities (treated as a cash distribution). These distributions exceed Alexandrias $90,000 basis and trigger recognition of a $20,000 gain. The accounts receivable and land must take a $0 basis because there is no remaining basis in Alexandrias interest. PTS: 1 DIF: 1 REF: Example 6 | Example 9 | Example 12 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 19. ANS: A Linas basis in the partnership interest is first reduced to $70,000 by the $10,000 cash distribution. The accounts receivable and inventory must take carryover bases of $0 and $30,000, respectively. This leaves a basis of $40,000 that is not allocated to assets Lina receives in the distribution. Because she received only cash, unrealized receivables, and inventory in the liquidating distribution, Lina must recognize that amount as a loss. PTS: 1 DIF: 1 REF: Example 9 | Example 14 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 20. ANS: D Choice a. is not correct because the relief of liabilities is treated as a cash distribution and is not limited by the partners basis in the partnership interest. Choice b. is not correct because the partners basis in unrealized receivables is the lesser of the partnerships basis in the receivables or the partners basis in the partnership interest immediately before their distribution. Choice c. is not correct because the basis in distributed inventory or unrealized receivables cannot be increased above the partnerships basis in those assets. Choice d. is correct because the order in which assets are deemed to be distributed is 1) cash (and relief of liabilities, plus certain marketable securities treated as cash distributions), 2) unrealized receivables and inventory, and 3) other assets. Choice e. is not correct because the partner must recognize a gain if cash distributions exceed the partners basis in the partnership interest. Also, the partner may recognize a loss if the partner receives only cash, unrealized receivables and inventory and the total partnerships basis in the distributed assets is less than the partners basis in the partnership interest before the distribution.

PTS: 1 DIF: 1 REF: p. 11-9 to 11-11 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 21. ANS: E Choice a. would be treated as a disguised sale. Choice b. would be treated as a cash distribution to the extent of the decrease in the recipient partners share of appreciation related to the property. Choice c. would be subject to the precontribution gain recognition rules because the property was distributed within seven years after the contribution date. Choice d. would also be subject to the precontribution gain recognition rules because the property was distributed to another partner within seven years following the contribution date. PTS: 1 DIF: 1 REF: p. 11-12 | p. 11-14 | Concept Summary 11.1 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 22. ANS: B Darby recognizes the precontribution gain when the property is distributed to Shelby. The amount of gain she recognizes is limited to the $20,000 precontribution gain at the contribution date. Darbys basis in the LLC is increased by her $20,000 recognized gain, to $90,000. When Shelby receives the property, her basis in the property is increased to $80,000 by the $20,000 of gain recognized by Darby. Shelbys basis in the partnership interest is reduced by the $80,000 basis of the distributed property. In this case, Darby recognizes a gain of $20,000, so Shelby increases her basis in the property from $60,000 to $80,000. PTS: 1 DIF: 1 REF: Example 18 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 23. ANS: C The precontribution gain on the property Jose originally contributed to the partnership was $10,000. The excess of the fair market value of the property distributed over Joses basis in his partnership interest (not the partnerships basis in the asset distributed), was $6,000 ($36,000 $30,000). The lesser of these two amounts must be recognized by Jose because the original property was contributed less than seven years prior to the distribution date. PTS: 1 DIF: 2 REF: Example 19 | Example 20 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 24. ANS: B Accounts receivable of a cash basis partnership have a $0 basis and result in ordinary income when the receivables are collected. Inventory with a basis of $16,000 and a value of $15,000 is not substantially appreciated and is not a hot asset. Depreciation recapture is ordinary income when realized and recognized. Land held for development is considered stock in trade, or inventory. PTS: 1 DIF: 2 REF: p. 11-24 to 11-26 OBJ: 4 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 25. ANS: B A payment for the LLCs goodwill is treated as a deductible amount under 736(a) if there is no provision for the payment in the LLCs operating agreement. If the payment is provided for, it will be treated as a 736(b) property payment; as such, the payment would not be deductible by the LLC. PTS: 1 OBJ: 4 | 5 MSC: 5 min DIF: 2 REF: p. 11-17 to 11-21 NAT: AICPA FN-Measurement | AACSB Analytic

26. ANS: C Because this is a liquidating distribution of a partner by an ongoing partnership, 736 applies. Choice a. is true because the cash payment for Teds share of the receivables is a 736(a) payment if capital is not a material income-producing factor of the partnership. Teds share of the receivables is $2,500 ($7,500 1/3). The 736(b) payments are $57,500, consisting of Teds one-third share of cash and capital assets and the $2,500 payment stated in the partnership agreement for goodwill [($165,000 1/3) + $2,500]. Payment for the $2,500 share of receivables is also a 736(b) property payment if capital IS a material income-producing factor. Goodwill is a 736(b) property payment whether or not capital is a material income-producing factor because payment of goodwill is provided for in the partnership agreement. Choice b., therefore, is also true. Choice d. is true because the 736(a) payment, if any, is a guaranteed payment that is deductible by the partnership and taxable as ordinary income. All of the choices are true except for choice c., because the payment for Teds share of goodwill is treated as a 736(b) return of basis/capital gain as it is provided for in the partnership agreement. PTS: 1 DIF: 2 REF: Example 24 to 27 OBJ: 5 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 27. ANS: D Choice a. is false because the selling partner must consider the share of partnership liabilities both in determining the selling price of the interest and the proceeds from the sale. Choice b. is false because the selling partner must adjust the basis in the partnership interest for any income allocated to that interest by the partnership through the sale date of the interest. Choice c. is false because the partner may be required to report a sale of a partnership interest to the IRS. Choice e. is false because the partners gain is allocated between ordinary income (related to sale of the partners share of partnership hot assets) and capital gain (related to sale of the partners share of the partnerships capital assets). PTS: 1 DIF: 2 REF: p. 11-22 to 11-26 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 28. ANS: B Nicholass beginning $50,000 basis is decreased by the $5,000 decrease in his share of LLC liabilities and increased by his $15,000 share of LLC income for the year ($120,000 25% 1/2 year), for a basis of $60,000 at the date the interest is sold. As the selling price of the interest was $95,000 ($80,000 cash plus $15,000 assumption of liabilities), Nicholass total gain is $35,000. Because his share of the LLCs hot asset is $6,000, he has $6,000 of ordinary income and the remaining $29,000 is capital gain. PTS: 1 DIF: 2 REF: Example 28 | Example 29 | Example 31 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 29. ANS: C Joseph had a $45,000 adjusted basis for his partnership interest that must be subtracted from the $65,000 proceeds. Section 751 requires the selling partner to recognize ordinary income when the partner effectively sells his proportionate share of partnership unrealized receivables. Joseph recognizes $15,000 of ordinary income and $5,000 of capital gain, calculated as follows: Ordinary income is $15,000. ($15,000 proceeds received for 1/3 share of unrealized receivables less $0 share of Josephs basis for the unrealized receivables.) Capital gain is $5,000. ($50,000 remaining proceeds received on the sale less $45,000 remaining outside basis for the interest.)

PTS: 1 DIF: 2 REF: Example 33 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 30. ANS: D Tinas overall gain is $34,000 [$64,000 (selling price) $30,000 (basis including share of liabilities)]. Tinas share of the partnerships unrealized receivables is $14,000; thus, she must recognize this amount of the gain as ordinary income. The remaining $20,000 is treated as capital gain. PTS: 1 DIF: 2 REF: Example 33 OBJ: 4 | 5 | 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 31. ANS: B Choice b. is not true. The partnership tax year generally closes with respect to the partner who transfers a partnership interest at death. PTS: 1 DIF: 2 REF: p. 11-22 to 11-26 | p. 11-28 OBJ: 6 | 7 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 32. ANS: D The amount of 743(b) adjustment is $33,000 ($73,000 purchase price for the interest $40,000 share of the inside basis of partnership assets). The fact that the fair value of Ambers share of the stated assets is only $63,000 is not relevant. The extra $10,000 is probably paid for partnership goodwill. The payment is reflected in Ambers basis in her partnership interest, and it should similarly be reflected in the step-up under 754. PTS: 1 DIF: 2 REF: Example 39 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 33. ANS: E Jordan receives only cash, unrealized receivables and inventory in a liquidating distribution. Therefore, he may report a capital loss of $10,000 ($90,000 basis $80,000 distribution) on the termination of his interest (choice d.). Section 734(b)(1)(A) provides that the partnership will step-down the basis of partnership assets by the amount of loss recognized by the distributee partner (choice a.). Therefore, the partnership has a downward adjustment to the basis of its assets in the amount of Jordans $10,000 loss. PTS: 1 DIF: 2 REF: Example 41 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 34. ANS: C Under 732(b), Ryan is limited to a basis of $5,000 in the capital assets received ($45,000 basis of partnership interest less $40,000 cash received). The partnerships $30,000 basis in the capital assets exceeds their $5,000 basis to Ryan by $25,000. Thus, if a 754 election is made, the partnership is entitled to increase the basis of its remaining property by $25,000. No gain or loss is recognized by the partnership, since the liquidating distribution is proportionate. PTS: 1 DIF: 2 REF: Example 40 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 35. ANS: C Brandons step-up is the difference between the amount he paid and his 1/3 share of the inside basis of partnership assets: Selling price ($80,000 cash + $5,000 assumption of liabilities) Partnerships basis in assets (1/3 $105,000) Step-up $85,000 (35,000) $50,000

PTS: 1 DIF: 1 REF: Example 39 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 36. ANS: A When a 754 election is in effect, the basis of partnership property is increased under 734 by the amount of gain recognized by the distributee and by the adjusted basis of distributed property to the partnership in excess of the adjusted basis of the property to the distributee. Conversely, it is decreased by any loss recognized by the distributee and by the adjusted basis of the property to the distributee in excess of the adjusted basis of the property to the partnership. As long as the election under 754 is in effect, such adjustments generally must be made. PTS: 1 DIF: 1 REF: p. 11-29 to 11-32 OBJ: 8 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 37. ANS: C A distribution is not considered a sale or exchange for termination purposes. Therefore, it does not result in technical termination of the partnership if the partnership continues in business after the distribution. PTS: 1 DIF: 1 REF: p. 11-32 | p. 11-33 OBJ: 9 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 38. ANS: D When a family member acquires a capital interest by gift in a family partnership in which capital is a material income-producing factor, the donor must be allocated an amount of partnership income that represents reasonable compensation for services performed for the partnership. The remaining partnership income generally is divided among the partners according to their profit- or loss-sharing agreement. However, the donees portion may not exceed the income allocable to the ownership of the capital interest. Courtneys capital interest is 25%. Of the $200,000 of partnership income, $40,000 is allocated to Rachel as compensation for services; the remainder is allocated $120,000 to Rachel and $40,000 to Courtney. PTS: 1 DIF: 1 REF: Example 46 OBJ: 10 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 39. ANS: B All members of an LLC generally have limited personal liability for debts of the LLC. This includes any members who participate in managing the LLC. PTS: 1 DIF: 1 REF: p. 11-35 | p. 11-36 OBJ: 11 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 40. ANS: C LLC members are subject to self-employment taxes on their share of the entitys income if they are active participants in the management of the LLC. Choices a., b., d., and e. are true statements. PTS: 1 OBJ: 11 MSC: 5 min MATCHING 1. ANS: J PTS: 1 DIF: 1 REF: p. 11-3 DIF: 1 REF: p. 11-35 to 11-37 NAT: AICPA FN-Measurement | AACSB Analytic

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC:

1 2 min L 1 2 min I 6 2 min E 6 2 min C 6 2 min H 4 2 min A 2 2 min L 1 2 min D 1 2 min B 6 2 min F 6 2 min G 8 2 min E 5 2 min I 5 2 min C 5 2 min H 5 2 min A

NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: No correct match NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-7 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-6 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-7 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-15 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-3 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: No correct match NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-6 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-15 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-15 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-29 NAT: AICPA FN-Reporting | AACSB Analytic

13. ANS: OBJ: MSC: 14. ANS: OBJ: MSC: 15. ANS: OBJ: MSC: 16. ANS: OBJ: MSC: 17. ANS:

PTS: 1 DIF: 1 REF: p. 11-18 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-18 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-18 to 11-20 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-18 to 11-20 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-22

18.

19.

20.

21.

22.

23.

24.

25.

OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC: ANS: OBJ: MSC:

6 2 min M 1 2 min F 5 2 min J 8 2 min K 8 2 min D 8 2 min B 8 2 min M 1 2 min G 9 2 min

NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: No correct match NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-18 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-29 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-29 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-30 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-29 NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: No correct match NAT: AICPA FN-Reporting | AACSB Analytic PTS: 1 DIF: 1 REF: p. 11-33 NAT: AICPA FN-Reporting | AACSB Analytic

26. ANS: B PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: A payment for partnership goodwill is only considered a 736(a) payment if (1) the partner is a general partner and (2) capital is not a material income-producing factor for the partnership. 27. ANS: B PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Even if the two requirements in 25. are met, goodwill is only a 736(a) payment if it is not provided for in the partnership agreement. 28. ANS: B PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: A payment for a partners share of inventory is always a 736(b) payment. This payment may, however, result in ordinary income to the retiring partner. 29. ANS: A PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Where a partner is general partner and capital is not a material income-producing factor for the partnership, payment for the partners share of unrealized receivables is considered an income payment under 736(a). 30. ANS: B PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5

NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Where a partner is a limited partner, payment for unrealized receivables is not an income payment, although it may result in ordinary income to the retiring partner. 31. ANS: A PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: An annuity to a retiring general partner is an income payment under 736(a). Since the annuity is determined with regard to partnership income, the payment is treated as a distributive share under 704(b) rather than a guaranteed payment. Therefore, the partnership does not deduct the payment, but the effect on the other partners is virtually identical to a deduction. 32. ANS: B PTS: 1 DIF: 1 REF: p. 11-18 to 11-22 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Both a payment for equipment and a payment for depreciation recapture related to the equipment are treated as 736(b) property payments. 33. ANS: A PTS: 1 DIF: 1 REF: p. 11-15 | p. 11-16 | p. 11-24 to 11-26 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Appreciated inventory is treated as a hot asset, so the appreciation will result in ordinary income to the partner in all three indicated cases. Note that for a sale of a partnership interest, inventory need not be appreciated. 34. ANS: C PTS: 1 DIF: 1 REF: p. 11-15 | p. 11-16 | p. 11-24 to 11-26 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Marketable securities would only be hot assets if they were held as inventory. 35. ANS: A PTS: 1 DIF: 1 REF: p. 11-15 | p. 11-16 | p. 11-24 to 11-26 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: A cash basis account receivable is an unrealized receivable and a hot asset for all three purposes. 36. ANS: C PTS: 1 DIF: 1 REF: p. 11-15 | p. 11-16 | p. 11-24 to 11-26 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Capital assets (and receivables related to capital assets) are not hot assets. 37. ANS: B PTS: 1 DIF: 1 REF: p. 11-15 | p. 11-16 | p. 11-24 to 11-26 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Land held for subdividing is inventory. It may or may not be substantially appreciated. 38. ANS: B PTS: 1 DIF: 1 REF: p. 11-15 | p. 11-16 | p. 11-24 to 11-26 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min NOT: Inventory that is not substantially appreciated is only a hot asset for purposes of sales of a partnership interest. PROBLEM 1. ANS: a. Chelsea will not recognize any gain or loss on the distribution because the $90,000 cash distributed does not exceed her $170,000 outside basis.

b.

The inventory has an adjusted basis of $80,000 to Chelsea. The partnership will distribute the $90,000 cash first, thereby reducing her outside basis for her partnership interest to $80,000 ($170,000 $90,000). The inventory will be distributed next, taking a substituted basis of $80,000 and reducing the adjusted basis for her partnership interest to $0. The land parcel is distributed last and takes a $0 substituted basis because Chelsea has no remaining basis in her partnership interest. Chelseas basis for her partnership interest after the distribution is $0. Her entire $170,000 outside basis has been allocated to the distributed assets in the following amounts: Cash Inventory Land $90,000 80,000 0 OBJ: 1 MSC: 10 min $90,000 (50,000) $40,000 (22,000) (18,000) 0

c.

d.

PTS: 1 DIF: 1 REF: Example 9 NAT: AICPA FN-Measurement | AACSB Analytic 2. ANS: Beginning basis in Melissas interest Less: Cash distribution Basis before property distributions Less: Inventory distribution Less: Land distribution Basis after property distributions

Melissas basis in the inventory equals the partnerships basis in the inventory. Whether the property is appreciated or depreciated does not matter. Her basis in the land is a substituted basis equal to the basis in the partnership interest following the inventory and cash distributions. PTS: 1 DIF: 1 REF: Example 4 | Example 9 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 3. ANS: a. Greg does not recognize a capital gain or loss on the liquidation of his partnership interest. He did not receive cash in excess of his basis in the partnership interest, so he does not recognize a gain. Also, because Greg received assets other than cash and hot assets, he may not recognize a loss. b. Gregs bases in the inventory and capital asset are $2,000 and $8,000, respectively. His basis is reduced to $10,000 by the cash distribution. The inventory is distributed next and takes a $2,000 carryover basis. The remaining $8,000 basis is allocated to the capital asset.

PTS: 1 DIF: 1 REF: Example 4 | Example 9 OBJ: 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 4. ANS: a. James does not recognize a capital gain or loss on the liquidation of his partnership interest. He did not receive cash in excess of his basis in the partnership interest, so he does not recognize a gain. Also, because James received assets other than cash and hot assets, he may not

recognize a loss. b. James takes a total substituted basis in the land of $60,000 (basis in interest of $85,000 less cash distribution of $25,000). That basis must be allocated between the two properties. First the properties take a carryover basis of $5,000 each. Next, the remaining basis is allocated to each property, up to its fair market value, resulting in basis allocations of $25,000 and $10,000, respectively. Last, the remaining $15,000 of basis is allocated between the properties according to their respective fair market values (bases after the second allocations): 2/3 of the $15,000 is added to the $30,000 basis of the first parcel and 1/3 is added to the $15,000 basis of the second parcel. Final basis allocations for parcel A and parcel B are $40,000 and $20,000, respectively.

PTS: 1 DIF: 1 REF: Example 13 OBJ: 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 5. ANS: a. Josh recognizes a $110,000 capital loss on the distribution. The loss is the difference between his $300,000 adjusted basis and the $190,000 ($70,000 + $120,000) inside basis of the cash and inventory distributed to him. b. Josh would not recognize any loss on the distribution and the land would take a $110,000 adjusted basis. A loss cannot be recognized if any assets other than cash, unrealized receivables, and inventory are received in the distribution. Because land is generally a capital asset, it will absorb all of the remaining basis of $110,000.

PTS: 1 DIF: 1 REF: Example 14 | Example 15 | Concept Summary 11.2 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 6. ANS: Christina will recognize $47,000 of ordinary income and $9,000 of capital gain. According to 736(a), the $40,000 ($120,000 1/3) paid for Christinas share of unrealized receivables will be taxed to her as a $40,000 guaranteed payment. In addition, the $7,000 ($140,000 $133,000) paid for her share of unstated goodwill will be treated as a guaranteed payment. The remaining $93,000 ($140,000 $47,000) cash distribution will be treated as a 736(b) payment. The first $84,000 of this payment will be a return of Christinas outside basis. The remaining $9,000 will be taxed to her as capital gain. PTS: 1 DIF: 2 REF: p. 11-17 to 11-21 OBJ: 5 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 7. ANS: The $25,000 payment for Danas share of the unrealized receivables is a 736(a) payment, taxed as ordinary income. Danas share of the receivables is $25,000 ($75,000 1/3). The 736(b) payment is $130,000, consisting of the amount paid for Danas 1/3 share of the partnership cash and capital assets. The 736(b) payment is treated first as a return of Danas $110,000 outside basis, and the remaining $20,000 is taxed to Dana as capital gain. PTS: 1 OBJ: 5 MSC: 10 min 8. ANS: DIF: 1 REF: p. 11-17 to 11-21 | Example 22 to 27 NAT: AICPA FN-Reporting | AACSB Analytic

Susan recognizes $25,000 of ordinary income and a $5,000 capital gain; the partnership cannot claim a deduction. Because Susan is a limited partner, SJs $25,000 payment for her share of unrealized receivables is treated as a 736(b) payment. As such, Susan recognizes ordinary income, but the partnership cannot claim a deduction. The remaining $75,000 payment exceeds Susans $70,000 basis in the partnership interest by $5,000; therefore, Susan recognizes a $5,000 capital gain on disposition of the interest. PTS: 1 DIF: 2 REF: Example 26 | Concept Summary 11.3 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 9. ANS: Rachels realized gain is $50,000 ($300,000 received less $250,000 outside basis). As the receivables are a 751 hot asset, Rachel is treated as having sold her 1/3 share and, therefore, will recognize $30,000 ordinary income. The rest of the sale is taxed under the general rule of 741 and generates a capital gain of $20,000. PTS: 1 DIF: 2 REF: Example 33 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 10. ANS: Hannahs basis is increased from $70,000 at the beginning of the year to $85,000 at the sale date, as a result of HIJKs allocation of $15,000 of income to her during the sale year. Her total gain is $35,000 ($120,000 sales price $85,000 basis). Hannah recognizes $20,000 of ordinary income under 751(a) and a $15,000 capital gain under 741. Hannah recognizes ordinary income to the extent of her share of the partnerships inventory and unrealized receivables. Hannahs 25% share of the receivables is $20,000 (25% $80,000). The difference between the amount Alyssa paid ($120,000) and Hannahs share of the value of partnership assets ($100,000) is probably the value of the partnerships intangible assets or goodwill. PTS: 1 DIF: 2 REF: Example 33 | Example 34 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 11. ANS: a. Jennifer has a 743(b) step-up adjustment of $24,000 under 754. The adjustment is determined by subtracting Jennifers $19,000 share of the inside basis of partnership assets from her $43,000 purchase price for the interest. b. Jennifer recognizes a $5,000 gain on the sale of the nondepreciable capital asset. When Jennifer acquires the partnership interest, the $24,000 743(b) adjustment is allocated to the capital asset under 755. When the partnership sells the capital asset for $120,000, Jennifer can offset $24,000 of the $29,000 [($120,000 $33,000) 1/3] gain she would otherwise recognize with the 743(b) adjustment. The remaining $5,000 of gain allocated to Jennifer is taxed to her on her return. DIF: 2 REF: p. 11-29 | p. 11-30 | Example 39 NAT: AICPA FN-Measurement | AACSB Analytic

PTS: 1 OBJ: 6 | 8 MSC: 10 min ESSAY

1. ANS: Cindy will prefer to treat the cash received for her share of the partnership goodwill as a 736(b) payment. Section 736(b) payments are taxed as a return of basis and capital gain to the recipient partner. The goodwill can be treated as a 736(b) payment if the partnership agreement provides for the goodwill. Unfortunately, the partnership probably will prefer to treat the payment for goodwill as a 736(a) payment, since this will allow the partnership to deduct the amounts paid for Cindys share of partnership goodwill. The payment for Cindys share of the goodwill will be treated as a 736(a) payment if the goodwill is not provided for in the partnership agreement. Cindy and the partnership can control how the goodwill will be treated. In situations such as this, the partnership typically has the more powerful position in the negotiations. This typically allows the partnership to dictate the treatment of goodwill as a 736(a) payment. PTS: 1 DIF: 2 REF: p. 11-17 to 11-21 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 10 min 2. ANS: a. The limited liability company (LLC) generally provides for Federal taxation under Subchapter K (partnership taxation) and limited liability for all owners. Therefore, it provides for the same protection from personal liability as a C corporation while providing for taxation of LLC operations at the owner level. The C corporation tax does not apply to an LLC. Partnership provisions such as optional adjustments to basis, special allocations of income, gain, loss, deduction and credit, and inclusion of all LLC liabilities in outside basis are additional advantages of an LLC over a C corporation. b. An existing C corporation should carefully weigh the consequences before converting to an LLC. The IRS has ruled that a C corporation must liquidate and re-form as an LLC. When a C corporation liquidates, any appreciation in corporate assets triggers a corporate level gain. This results in immediate double taxation of the gain (at the corporate level, then as a shareholder gain or loss on liquidation of the entity). [Note: In challenging economic times, this tax cost could be lower if asset values are depressed.] A partnership, on the other hand, does not liquidate when it converts to an LLC, and any appreciation in partnership assets remains untaxed. DIF: 2 REF: p. 11-35 | p. 11-36 NAT: AICPA FN-Reporting | AACSB Analytic

PTS: 1 OBJ: 11 MSC: 10 min