Question 1

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

If a partner is unable to use the loss that has been allocated to them, the partner can carry the loss forward indefinitely. The loss will be suspended until the partner has enough tax basis to be able to utilize the suspended loss.

Question 2

On March 15, 20X9, Troy, Peter, and Sarah formed Picture Perfect general partnership. This partnership was created to sell a variety of cameras, picture frames, and other photography accessories. When it was formed, the partners received equal profits and capital interests and the following items were contributed by each partner:
• Troy - cash of $3,000, inventory with a FMV and tax basis of $5,000, and a building with a FMV of $22,000 and adjusted basis of $10,000. Additionally, the building was secured by a $10,000 nonrecourse mortgage.
• Peter - cash of $5,000, accounts payable of $12,000 (recourse debt for which each partner becomes equally responsible), and land with a FMV of $27,000 and tax basis of $20,000.
• Sarah - cash of $2,000, accounts receivable with a FMV and tax basis of $1,000, and equipment with a FMV of $40,000 and adjusted basis of $3,500. Sarah also contributed a $23,000 nonrecourse note payable secured by the equipment.
What is each partner's outside basis and how much gain (loss) must the partners recognize in 20X9 when Picture Perfect was formed?

Accepted Answer

The answer of On March 15, 20X9, Troy, Peter, and...

Question 3

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

When a partner receives a cash distribution in excess of her tax basis, she must generally recognize a capital gain rather than reduce her basis below zero.

Question 4

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 twice when he sells his partnership interest because he was not taxed on this income when it was earned
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

Adjusting a partner's basis for his share of tax-exempt income or nondeductible expenses prevents these items from ever being taxed or deducted.

Question 5

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 these

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 6

J&J, LLC was in its third year of operations when J&J decided to expand the number of members from two, A & B, with equal profits and capital interests to three members, A, B, and C. The third member, C, will contribute her financial expertise to the LLC in exchange for a 1/3 capital interest in J&J. Given the balance sheet below reflecting the financial position of J&J on the date member C is admitted, what are the tax consequences to members A, B, and C, and to J&J when C receives her capital interest? If, instead, member C receives a 1/3 profit interest, what would be the tax consequences to members A, B, and C, and to J&J?
 $$\begin{array}{l}
\text { Presidential Suites Partnership }\
\begin{array} { | l | c | c | c | } 
\hline & \text { Year-End } & \text { Profits } & \text { Capital } \
\hline \text { Lincoln, Inc. } & 3 / 31 & 35 \% & 30 \% \
\hline \text { Washington, Inc. } & 7 / 31 & 30 \% & 40 \% \
\hline \text { Blaster, Inc } & 11 / 30 & 35 \% & 30 \% \
\hline
\end{array}
\end{array}$$

Accepted Answer

The answer of J&J, LLC was in its third year...

Question 7

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.

Question 8

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

A partner's at-risk amount typically reflects the partner's potential economic risk of loss associated with holding the partnership interest. Consequently, nonrecourse debt is generally not included in the at-risk amount. However, qualified nonrecourse debt is an exception to this general rule and is included in the at-risk amount.

Question 9

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

A partner's share of additional partnership debt is treated as a deemed contribution of cash increasing a partner's basis. On the other hand, a partner's share of any partnership debt relief is treated as a deemed cash distribution reducing a partner's basis.

Question 10

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 11

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 12

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 basis is increased by her share of ordinary business income and tax-exempt income and then reduced by her actual cash distribution and deemed cash distribution from the reduction in her share of partnership debt. Because her actual and deemed cash distributions exceed her basis after increasing it by the positive adjustments for the year, Hilary must report $12,000 of capital gain leaving her with a zero basis in her partnership interest. ($10,000 + $5,000 + $3,000 - $10,000 - $20,000 = ($12,000) + $12,000 = 0).

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. 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

Jay would first apply the loss against his tax basis. Since his tax basis is only $14,000, $1,000 of his $15,000 loss is suspended due to the tax basis limitation. Because Jay's at-risk amount is only $13,500 ($14,000 - $500), an additional $500 of Jay's remaining $14,000 loss is suspended because of the at-risk limitation leaving Jay with only $13,500 of loss that he could deduct currently.

Question 14

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 15

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

An individual would be considered a material participant in all of these circumstances except for an individual who participated in the activity for at least one of the preceding five taxable years. The statement regarding an individual who participated in the activity for at least one of the preceding five taxable years would be correct if it were phrased as: "the taxpayer must have participated in the activity for any 5 of the preceding 10 taxable years."

Question 16

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

All these rationales describe the reasoning for adjusting a partner's basis on an annual basis.

Question 17

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 initial tax basis is increased by his cash contribution and share of separately-stated items (long-term capital gain and qualified dividends). His basis is then reduced by his share of the reduction in partnership debt, non-deductible expenses, and ordinary loss ($50,000 + $10,000 + $3,000 + $2,000 - $4,000 - $500 - $15,000 = $45,500).

Question 18

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 these will affect a partner's tax basis

Accepted Answer

A partner's share of partnership ordinary business income (loss) as well as any type of partnership debt (recourse, nonrecourse, etc.) will affect the tax basis of her partnership interest.

Question 19

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 these. 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 20

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

The analysis below indicates how Jane as well of the other members of Styling would arrive at their basis in Styling at the end of 20X8.

Quiz 15: Forming and Operating Partnerships

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

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?

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

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

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

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

In what order are the loss limitations for partnerships applied?

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 would not be classified as a material participant in an activity?

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

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

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?