QUESTION 3 The XYZ partnership has been operating for several years. All of its
ID: 2332517 • Letter: Q
Question
QUESTION 3
The XYZ partnership has been operating for several years. All of its assets were purchased by the partnership, and at the end of the current year it’s balance sheet, which has been expanded to show the current fair market value of assets and capital, is as follows:
Assets
Liabilities & Capital
AB/Book
FMV
Liabilities
Cash
$600
$600
None
Accts. Rec.
0
200
Equipment
100
200
Stock
500
1000
Land
300
1000
Total
$1500
$3000
Capital Accounts
Tax/Book
FMV
X
$500
$1000
Y
500
1000
Z
500
1000
$1500
$3000
On the last day of the current year, W joins the partnership. In exchange for a contribution of $1000 cash, she receives a 25% interest in partnership profits, losses, and capital.
Reconstruct the balance sheet of the partnership following W’s admission to the partnership, assuming, in the alternative:
The partnership does not elect to revalue its assets under § 1.704- 1(b)(2)(iv)(f), or
The partnership does elect to revalue its assets under the regulations.
If W had purchased X’s interest in the partnership instead of acquiring an interest through a contribution to the partnership, would the partnership be permitted to revalue its assets under the regulations? Why or why not?
Assets
Liabilities & Capital
AB/Book
FMV
Liabilities
Cash
$600
$600
None
Accts. Rec.
0
200
Equipment
100
200
Stock
500
1000
Land
300
1000
Total
$1500
$3000
Capital Accounts
Tax/Book
FMV
X
$500
$1000
Y
500
1000
Z
500
1000
$1500
$3000
Explanation / Answer
As W joins he will recognize one fourth of the fair market value of the partnership capital or $3000/4
$750 as ordinary income.
Therefore W basis in the partnership interest will be equal to the amount of income he reports or $750.
Immedaitely after W admission into the partnership the partnership Balance Sheet will be appear as follows:
XYZ Partnership
Balance Sheet
Tax Basis 704(b)/FMV
Assets
Cash $600 600
Land $300 1000
Inventory $500 1000
Accounts Rece $0 200
Equipment $100 200
Total $1500 3000
Capital
Capital-X $250 750
Capital-Y $250 750
Capital-Z $250 750
Capital-W $750 750
Total $1500 3000
Esentially the tax capital and 704(b) capital accounts for both X,Y and Z are deducted of the compensation expense the partnership will deduct for the capital interest W receives.
If W only receives the profit interest he will not recognize any income he receives a profit allocation from the partnership.
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