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

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

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

 Partner’s basis in partnership interest Cash contributed plus:Basis of property transferred plus:Gain recognized less:Liabilities allocable to other partners equals:Initial basis Cengage Learning

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

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

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

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

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

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