Question 1

On January 1,X9,Gerald received his 50% profits and capital interest in High Air,LLC in exchange for $2,000 in cash and real property with a $3,000 tax basis secured by a $2,000 nonrecourse mortgage.High Air reported a $15,000 loss for its X9 calendar year.How much loss can Gerald deduct,and how much loss must he suspend if he only applies the tax basis loss limitation?
A)$0,$4,000.
B)$0,$7,500.
C)$0,$15,000.
D)$4,000,$0.
E)None of the choices are correct.

Accepted Answer

Gerald's initial tax basis is $4,000 [$2,000 + $3,000 - $2,000 + (50% × $2,000)]. Gerald would be allocated 50% of the $15,000 X9 loss, or $7,500. The amount Gerald could deduct currently is limited to his basis in High Air. Thus, Gerald could deduct $4,000 currently, and the remaining $3,500 loss would be suspended and carried forward indefinitely.

Question 2

Does adjusting a partner's basis for tax-exempt income prevent double taxation?
A)Yes,if this basis adjustment is not made the partner will be taxed once when the income is allocated to him and a second time when he sells his partnership interest.
B)Yes,if this basis adjustment is not made the partner will be taxed on the tax-exempt income when he sells his partnership interest and again if the tax-exempt income exceeds $10,000.
C)No,making this adjustment to the partner's basis prevents the tax-exempt income from being converted to taxable income.
D)No,the partner should not adjust his tax basis by his share of tax-exempt income.

Accepted Answer

The answer of Does adjusting a partner's basis for tax-exempt...

Question 3

Which of the following statements regarding the rationale for adjusting a partner's basis is false?
A)To prevent partners from being double taxed when they sell their partnership interests.
B)To ensure that partnership tax-exempt income is not ultimately taxed.
C)To prevent partners from being double taxed when they receive cash distributions.
D)To ensure that partnership non-deductible expenses are never deductible.
E)None of these rationales are false.

Accepted Answer

Adjusting a partner's basis in a partnership is crucial for tax purposes, including preventing double taxation on the sale of partnership interests (A), ensuring tax-exempt income remains untaxed (B), avoiding double taxation on cash distributions (C), and properly handling nondeductible expenses (D). Therefore, none of the provided rationales are false.

Question 4

What is the difference between the aggregate and entity theory of partnership taxation? Provide two examples of how partnership tax rules reflect the aggregate theory and two examples of how they reflect the entity theory.

Accepted Answer

The answer of What is the difference between the aggregate...

Question 5

Which of the following items will affect a partner's tax basis?
A)Share of ordinary business income (loss).
B)Share of nonrecourse debt.
C)Share of recourse debt.
D)Share of qualified nonrecourse debt.
E)All of the choices will affect a partner's tax basis.

Accepted Answer

All of the choices will affect a partner's tax basis. The partner's tax basis is the amount of the partner's investment in the partnership, and it is adjusted to reflect changes in the partner's share of the partnership's income, deductions, gains, losses, and liabilities. Share of ordinary business income (loss) affects a partner's basis because it increases or decreases the partner's share of the partnership's income or loss, which in turn affects the partner's investment in the partnership. Share of nonrecourse debt affects a partner's basis because the partner is not personally liable for the debt, but the debt increases the partner's investment in the partnership. Share of recourse debt affects a partner's basis because the partner is personally liable for the debt, and the debt increases the partner's investment in the partnership. Share of qualified nonrecourse debt affects a partner's basis because the partner is not personally liable for the debt, but the debt is secured by real property used in the partnership's business, and the debt increases the partner's investment in the partnership.

Question 6

Jerry,a partner with 30% capital and profit interest,received his Schedule K-1 from Plush Pillows,LP.At the beginning of the year,Jerry's tax basis in his partnership interest was $50,000.His current year Schedule K-1 reported an ordinary loss of $15,000,long-term capital gain of $3,000,qualified dividends of $2,000,$500 of non-deductible expenses,a $10,000 cash contribution,and a reduction of $4,000 in his share of partnership debt.What is Jerry's adjusted basis in his partnership interest at the end of the year?
A)$35,000.
B)$40,000.
C)$45,500.
D)$49,500.

Accepted Answer

- Jerry's share of the ordinary loss is $15,000 x 30% = $4,500. This reduces his tax basis to $50,000 - $4,500 = $45,500.
- The long-term capital gain of $3,000 is included in Jerry's taxable income, but it does not affect his tax basis.
- The qualified dividends of $2,000 are also included in Jerry's taxable income, but they do not affect his tax basis.
- The $500 of non-deductible expenses do not affect Jerry's tax basis.
- The $10,000 cash contribution increases Jerry's tax basis to $45,500 + $10,000 = $55,500.
- The reduction in Jerry's share of partnership debt of $4,000 increases his tax basis to $55,500 + $4,000 = $49,500.
Therefore, the adjusted basis in his partnership interest at the end of the year is $49,500.

Question 7

If partnership debt is reduced and a partner is deemed to receive a cash distribution,what impact does the deemed distribution have on the partner if it is in excess of her tax basis?
A)The partner will treat the distribution in excess of her basis as ordinary income.
B)The partner will treat the distribution in excess of her basis as capital gain.
C)The partner will not ever be taxed on the distribution in excess of her basis.
D)The partner will not be taxed on the distribution in excess of her basis until she sells her partnership interest.

Accepted Answer

The partner will treat the distribution in excess of her basis as capital gain. This is because distributions from a partnership to a partner that exceed the partner's basis in the partnership are treated as a sale or exchange of the partnership interest, which generally results in capital gain.

Question 8

What is the correct order for applying the following three items to adjust a partner's tax basis in his partnership interest: (1)Increase for share of ordinary business income,(2)Decrease for share of separately stated loss items,and (3)Decrease for distributions?
A)1,3,2.
B)1,2,3.
C)3,1,2.
D)2,3,1.

Accepted Answer

The answer of What is the correct order for applying...

Question 9

Styling Shoes,LLC filed its 20X8 Form 1065 on March 15,20X9.Styling had three members with the following ownership interests and tax basis at the beginning of the 20X8: (1)Jane,a member with a 25% profits and capital interest and a $5,000 outside basis,(2)Joe,a member with a 45% profits and capital interest and a $10,000 outside basis,and (3)Jack,a member with a 30% profits and capital interest and a $2,000 outside basis.The following items were reported on Styling's Schedule K for the year: ordinary income of $100,000,Section 1231 gain of $15,000,charitable contributions of $25,000,and tax-exempt income of $3,000.In addition,Styling received an additional bank loan of $12,000 during 20X8.What is Jane's tax basis after adjustment for her share of these items?
A)$28,250.
B)$31,250.
C)$33,500.
D)$57,250.

Accepted Answer

To determine Jane's ending tax basis, we need to calculate her share of the following items:

1) Ordinary income of $100,000: 
- Jane's share is 25%, or $25,000. This increases her basis to $30,000 ($5,000 beginning basis + $25,000 share of ordinary income).

2) Section 1231 gain of $15,000: 
- This is not included in ordinary income, but rather reported separately on Schedule K. Jane's share of the gain is 25%, or $3,750. This increases her basis to $33,750 ($30,000 adjusted basis from #1 + $3,750 share of Section 1231 gain).

3) Charitable contributions of $25,000: 
- This reduces Styling's taxable income and, therefore, reduces each member's share of ordinary income. We need to calculate Jane's share of the reduced ordinary income first: 
- Original ordinary income of $100,000 minus $25,000 charitable contributions = $75,000 
- Jane's share of the reduced ordinary income is 25%, or $18,750.
- This reduces her basis to $15,000 ($33,750 adjusted basis from #2 - $18,750 share of reduced ordinary income).

4) Tax-exempt income of $3,000: 
- This is not included in taxable income and does not affect Jane's basis.

5) Additional bank loan of $12,000: 
- This increases Styling's liabilities, which reduces each member's basis. Jane's share of the liability is 25%, or $3,000. This reduces her basis to $12,000 ($15,000 adjusted basis from #3 - $3,000 share of additional bank loan).

Therefore, Jane's tax basis after adjustment for her share of these items is $31,250 ($12,000 adjusted basis from #5 + $18,750 share of reduced ordinary income from #3).

Question 10

Which of the following statements regarding a partner's basis adjustments is true?
A)A partner's basis may never be reduced below zero.
B)A partner must adjust his basis for ordinary income (loss)but not for separately stated items.
C)A partnership fine or penalty paid by the partnership does not affect a partner's basis.
D)Relief of partnership debt increases a partner's tax basis.

Accepted Answer

The answer of Which of the following statements regarding a...

Question 11

If a taxpayer sells a passive activity with suspended passive activity losses from prior years,what type of income can be offset by the suspended passive losses in the year of sale?
A)Passive activity income.
B)Portfolio income.
C)Active business income.
D)Any of these types of income can be offset.
E)None of the choices are correct.The suspended losses disappear when the passive activity is sold.

Accepted Answer

Suspended passive activity losses are available to offset any type of income in the year the passive activity is sold.

Question 12

In what order are the loss limitations for partnerships applied?
A)Tax Basis - At-Risk Amount - Passive Activity Loss.
B)Passive Activity Loss - Tax Basis - At-Risk Amount.
C)Tax Basis - Passive Activity Loss - At-Risk Amount.
D)At-Risk Amount - Tax Basis - Passive Activity Loss.

Accepted Answer

Partnership losses are first limited by the partner's tax basis, then by the partner's at-risk amount. Any remaining passive loss may only be deducted if the partner also has passive income. Any suspended losses are carried forward indefinitely.

Question 13

Jay has a tax basis of $14,000 in his partnership interest at the beginning of the partnership tax year.The following amounts of partnership debt were allocated to Jay and are included in his beginning of the year tax basis: (1)recourse debt - $3,000,(2)qualified nonrecourse debt - $1,000,and (3)nonrecourse debt - $500.There were no changes to the debt allocated to Jay during the tax year.  If Jay is allocated a $15,000 loss for the current year,how much of the loss will be suspended under the tax basis and at-risk limitations?
A)$500,$1,000.
B)$1,000,$500.
C)$0,$0.
D)$14,000,$1,000.

Accepted Answer

To calculate the amount of loss suspended under the tax basis and at-risk limitations, we need to compare Jay's tax basis and at-risk amount with his share of partnership losses.

Tax basis calculation: 
Beginning tax basis = $14,000
Plus: allocated recourse debt = $3,000
Plus: allocated qualified nonrecourse debt = $1,000
Plus: allocated nonrecourse debt = $500
Total tax basis = $18,500

At-risk calculation: 
Beginning at-risk amount = $14,000
Plus: allocated qualified nonrecourse debt = $1,000
Total at-risk amount = $15,000

Since Jay's tax basis and at-risk amount are both greater than his share of partnership losses ($15,000), none of the loss will be suspended under the tax basis and at-risk limitations. Therefore, the answer is B) $1,000, $500.

Question 14

Which of the following statements regarding partnerships losses suspended by the tax basis limitation is true?
A)Partnership losses must be used only in the year the losses are created.
B)Partnership losses may be carried back 2 years and carried forward 5 years.
C)Partnership losses may be carried forward indefinitely.
D)Partnership losses may be carried back 2 years and carried forward 20 years.

Accepted Answer

Partnership losses that are suspended by the tax basis limitation may be carried forward indefinitely. This means that they may be used in future years when the partnership generates taxable income, subject to further limitations. The other options are incorrect: partnership losses may not be carried back, and the carryforward period is not limited to 5 or 20 years.

Question 15

Hilary had an outside basis in LTL,General Partnership of $10,000 at the beginning of the year.LTL reported the following items on Hilary's K-1 for the year: ordinary business income of $5,000,a $10,000 reduction in Hilary's share of partnership debt,a cash distribution of $20,000,and tax-exempt income of $3,000.What is Hilary's adjusted basis at the end of the year?
A)($12,000).
B)($9,000).
C)$0.
D)$15,000.
E)$18,000.

Accepted Answer

Hilary's adjusted basis calculation: Starting basis of $10,000 + $5,000 ordinary business income + $3,000 tax-exempt income - $10,000 reduction in share of partnership debt - $20,000 cash distribution = $0. The basis cannot go below zero, so the correct answer is $0.

Question 16

How does additional debt or relief of debt affect a partner's basis?
A)Debt has no effect on a partner's basis.
B)Relief of debt increases a partner's basis.
C)Both additional debt and relief of debt increase a partner's basis.
D)Additional debt increases a partner's basis.

Accepted Answer

Additional debt increases a partner's basis. When a partnership takes on additional debt, each partner's share of the debt is added to their individual basis. Relief of debt, on the other hand, decreases a partner's basis.

Question 17

Which of the following would not be classified as a material participant in an activity?
A)An individual who participates more than 100 hours a year and the person's participation is not less than any other individual's participation.
B)An individual who participated in the activity for at least one of the preceding five taxable years.
C)An individual who participates in an activity regularly,continuously,and substantially.
D)An individual who participates in an activity for more than 500 hours a year.

Accepted Answer

Participation in the activity for at least one of the preceding five taxable years is not a criterion for determining material participation status. The other options all describe individuals who would be considered material participants.

Question 18

What type of debt is not included in calculating a partner's at-risk amount?
A)Recourse debt.
B)Qualified nonrecourse debt.
C)Nonrecourse debt.
D)All of these types of debt are included in the at-risk amount.

Accepted Answer

Nonrecourse debt is not included in calculating a partner's at-risk amount because the partner is not personally liable for the debt.

Question 19

John,a limited partner of Candy Apple,LP,is allocated $30,000 of ordinary business loss from the partnership.Before the loss allocation,his tax basis is $20,000 and at-risk amount is $10,000.John also has ordinary business income of $20,000 from Sweet Pea,LP as a general partner and ordinary business income of $5,000 from Red Tomato,as a limited partner.How much of the $30,000 loss from Candy Apple can John deduct currently?
A)$5,000.
B)$10,000.
C)$25,000.
D)$30,000.

Accepted Answer

John would first compare the $30,000 loss to his tax basis of $20,000. As a result, John would have $10,000 of this loss suspended due to the tax basis limitation. Next, John would compare the remaining $20,000 loss with his $10,000 at-risk amount. Thus, an additional $10,000 of loss would be suspended due to the at-risk limitation leaving $10,000 of loss. Because John is a limited partner in Candy Apple, this loss is a passive activity loss. $5,000 of John's $10,000 passive activity loss from Candy Apple can be used currently to offset his passive income from Red Tomato. The remaining $(5,000) is suspended as a passive activity loss.

Question 20

Which person would generally be treated as a material participant in an activity?
A)A participant in a rental activity.
B)A limited partner.
C)A LLC member not involved with management of the LLC.
D)A general partner.

Accepted Answer

Limited partners and participants in rental activities are generally deemed to be passive participants. In addition, non-managing LLC members would typically not be treated under the regulations as having a level of involvement that is "regular, continuous, and substantial." However, general partners are likely to satisfy this definition of material participation.

Quiz 14: Forming and Operating Partnerships

Does adjusting a partner's basis for tax-exempt income prevent double taxation?

Which of the following statements regarding the rationale for adjusting a partner's basis is false?

What is the difference between the aggregate and entity theory of partnership taxation? Provide two examples of how partnership tax rules reflect the aggregate theory and two examples of how they reflect the entity theory.

Which of the following items will affect a partner's tax basis?

If partnership debt is reduced and a partner is deemed to receive a cash distribution,what impact does the deemed distribution have on the partner if it is in excess of her tax basis?

What is the correct order for applying the following three items to adjust a partner's tax basis in his partnership interest: (1) Increase for share of ordinary business income,(2) Decrease for share of separately stated loss items,and (3) Decrease for distributions?

Which of the following statements regarding a partner's basis adjustments is true?

If a taxpayer sells a passive activity with suspended passive activity losses from prior years,what type of income can be offset by the suspended passive losses in the year of sale?

In what order are the loss limitations for partnerships applied?

Which of the following statements regarding partnerships losses suspended by the tax basis limitation is true?

How does additional debt or relief of debt affect a partner's basis?

Which of the following would not be classified as a material participant in an activity?

What type of debt is not included in calculating a partner's at-risk amount?

Which person would generally be treated as a material participant in an activity?