Partnerships, Real Estate, and Selected Basis Issues Bill Johnson, CPA, ABV Jeff Olson, CPA Babush, Neiman, Kornman & Johnson, LLP

A Universal Given???? Cost = Basis or, to say it another way, Basis = Cost Is either just what was paid? What is “cost basis”?

What’s the Big Deal About Basis????? Transaction economics and tax accounting may differ! Why? Transactions negotiated on fair value Tax accounting may record them at something other than negotiated value Carry over cost basis (as in 1031 exchanges with deferred gain) But, not always

What’s the Big Deal About Basis????? It effects reported gain Who reports it How much

What is Cost? Seems simple, but that depends: Whose cost? The partner’s or the partnership’s Inside basis/outside basis Depending on which you mean, then you have to determine Is it reflected, or not, on the partnership’s books/tax records?

Partnership Basis Topics IRC Code Sections 721/704 and 754 Only an overview It is very complex What gives rise to these complicated tax accounting rules? Can tax basis presentations ever have any useful meaning if they are not always based on the value/economics of a deal?

Problem Cause #1 A Partner’s contribution of property to, or distributions from, a partnership generally do not trigger a recognizable tax event - Section 721 This is generally a good thing - deferred recognition of appreciation gains It just screws up the tax accounting relative to the “deal” economics

Basic Example - No Issues

Basic Example Issue

Assets Subject to Debt Other potential complications What if the asset is not sold, but held for rental and depreciated? What if only part of the project is sold in a tax year? ● What cost is being depreciated? ● How is it allocated among the partners?

Complex Example Issue

Assets Subject to Debt Contributions of assets subject to debt can trigger recognizable gain to the contributing partner But limited to the proportion of the debt shifted to other partners Up to the debt in excess of his basis in the contributed asset

Assets Subject to Debt

Complex Example Issue

The Problem Cause #2 Transactions between partners may give rise to accounting on the partnership’s books: Home Depot example Partnerships are different!

Example 754 Issue Sale of partnership interest Assets are adjusted upward (stepped up) to account for the value paid by the new partner The purchase value of a new partner’s interest is “pushed down” to the partnership Partner’s capital account at the date of contribution equals his purchase price

Example 754 Issue

Section 754 Effects Acquiring partner’s stepped up basis gives appropriately larger depreciation deductions to that partner Upon sale, increased basis reduces gain recognizable to that partner Former partners are unaffected Only a proportionate step up --- not to 100% of asset values as in 704(c)

Contribution of Development Fees Contribution of services, immediate capital account credit (capital interest ) ● equals immediate taxable income---ordinary Distribution priority (future profits interest) ● No immediate tax event ● If partnership gains are capital, then some of the “services” treated as capital gain