Prentice Hall's Federal Taxation 2015 Comprehensive, 28e (Pope)

Chapter C10 Special Partnership Issues

1) A partnership cannot recognize a gain or loss on a current distribution.
Answer: FALSE
Page Ref.: C:10-2
Objective: 1

2) If a partnership asset with a deferred precontribution gain is distributed within seven years of
acquisition in a nonliquidating distribution to a partner who did not contribute the asset, the
precontribution gain must be recognized by the contributing partner.
Answer: TRUE
Page Ref.: C:10-2
Objective: 1

3) In a current distribution, the partner's basis in the partnership interest is reduced by the amount of
money received and by the partnership's bases in the distributed property.
Answer: TRUE
Page Ref.: C:10-4
Objective: 1

4) A partner's holding period for property distributed as a current distribution begins on the date of
distribution.
Answer: FALSE
Page Ref.: C:10-7
Objective: 1

5) Under Sec. 751, unrealized receivables include potential Section 1245 or 1250 recapture on the
partnership's depreciable property.
Answer: TRUE
Page Ref.: C:10-8
Objective: 2

6) For Sec. 751 purposes, "substantially appreciated inventory" means property held for sale to customers
whose market value exceeds its adjusted basis.
Answer: FALSE
Page Ref.: C:10-12
Objective: 2

7) A partner can recognize gain, but not loss, on a liquidating distribution.

Answer: FALSE
Page Ref.: C:10-14
Objective: 3

8) A partner's holding period for a partnership interest is never considered when determining the holding
period for property distributed in a liquidating distribution.
Answer: TRUE
Page Ref.: C:10-16 and C:10-17
Objective: 3

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9) The sale of a partnership interest always results in capital gain or loss rather than ordinary income.
Answer: FALSE
Page Ref.: C:10-16 through C:10-18
Objective: 3

10) When a retiring partner receives payments that exceed the value of that partner's partnership
property, the excess payment is a guaranteed payment.
Answer: FALSE
Page Ref.: C:10-19
Objective: 4

11) Under the check-the-box rules, an LLC with more than one member is taxed as a partnership unless it
elects to be taxed as a corporation.
Answer: TRUE
Page Ref.: C:10-21
Objective: 4

12) A limited liability company is a form of business entity that combines the legal benefits of the
corporate form with the tax benefits of the partnership form.
Answer: TRUE
Page Ref.: C:10-30
Objective: 6

13) A new partner, Gary, contributes cash and assumes a share of partnership liabilities. Diane's capital,
profits, and loss interest in the partnership is reduced by 5% due to the admission of Gary. The Sec. 751
rules do not apply. Partnership liabilities at the time Gary is admitted are $200,000, and all of the liabilities
are recourse debts for which the partners share the economic risk of loss in the same way they share
partnership profits. Diane's basis in the partnership interest prior to Gary's admission is $5,000. Due to
the admission of Gary, partner Diane has
A) no recognized gain or loss and a partnership interest basis of $10,000.
B) no recognized gain or loss.
C) a recognized gain of $5,000 and a partnership interest basis of zero.
D) a recognized gain of $5,000 and a partnership interest basis of $5,000.
Answer: C
Explanation: C) Diane's reduction in partnership liabilities by the addition of Gary is $10,000 (0.05
$200,000 = $10,000). Because the $10,000 reduction is deemed cash distributed, Diane has a gain equal to
the excess of the cash deemed distributed over her basis:
Cash deemed distributed
Minus: original basis
Gain recognized

$10,000
( 5,000)
$ 5,000

The new basis of Diane's partnership interest is zero.

Page Ref.: C:10-2
Objective: 1

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14) If a distribution occurs within ________ years of the contribution date, in a nonliquidating distribution
that does not qualify for Sec. 751 treatment, the distribution event may trigger a precontribution gain or
loss.
A) three
B) five
C) seven
D) unlimited
Answer: C
Page Ref.: C:10-2
Objective: 1

15) Mirabelle contributed land with a $5,000 basis and a $9,000 FMV to MS Partnership four years ago.
This year the land is distributed to Sergio, another partner in the partnership. At the time of distribution,
the land had a $12,000 FMV. How much gain should Mirabelle and Sergio recognize?
A)
Mirabelle
0

Sergio
0

B)
Mirabelle
$4,000

Sergio
0

C)
Mirabelle
$4,000

Sergio
$3,000

D)
Mirabelle
$5,500

Sergio
$1,500

Answer: B

Page Ref.: C:10-3; Example C:10-2

Objective: 1

16) Mirabelle contributed land with a $5,000 basis and a $9,000 FMV to MS Partnership four years ago.
This year the land is distributed to Sergio, another partner in the partnership. At the time of distribution,
the land had a $12,000 FMV. What is the impact of the distribution on Mirabelle's partnership basis?
A) 0
B) $4,000 increase
C) $4,000 decrease
D) $7,000 increase
Answer: B
Page Ref.: C:10-3; Example C:10-2
Objective: 1

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17) Susan contributed land with a basis of $6,000 and an FMV of $10,000 to the SH Partnership two years
ago to acquire her partnership interest. This year, the land is distributed to Harry when its FMV is
$11,000. No other distributions have been made since Susan became a partner. When the land is
distributed, the partnership's basis in the land immediately before distribution is increased by
A) $0.
B) $1,000.
C) $4,000.
D) $5,000.
Answer: C
Page Ref.: C:10-3; Example C:10-2
Objective: 1

18) Helmut contributed land with a basis of $5,000 and an FMV of $10,000 to the HG Partnership five
years ago to acquire a 50% partnership interest. This year the land is distributed to another partner, Gail,
when its FMV is $11,000. No other distributions have been made since Helmut became a partner. When
the land is distributed to Gail, Helmut recognizes a gain of
A) $0.
B) $2,500.
C) $3,000.
D) $5,000.
Answer: D
Page Ref.: C:10-3; Example C:10-2
Objective: 1

19) Becky has a $24,000 basis in her partnership interest. She receives a current distribution of $4,000 cash,
unrealized receivables with a basis of $12,000 and an FMV of $16,000, and land held as an investment
with a basis of $3,000 and an FMV of $8,000. The partners' relative interests in the Sec. 751 assets do not
change as a result of the current distribution. The basis of her partnership interest following the
distribution is
A) $5,000.
B) $1,000.
C) $0.
D) ($4,000).
Answer: A
Explanation: A)
Predistribution basis
$24,000
Minus: cash
( 4,000)
unrealized receivables
(12,000)
land
( 3,000)
Postdistribution basis
$ 5,000
Page Ref.: C:10-4; Example C:10-6
Objective: 1

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20) John has a basis in his partnership interest of $30,000. He receives a current distribution of $6,000 cash,
unrealized receivables (FMV $11,000, basis $10,000), inventory (FMV $8,000, basis $4,000), and investment
land (FMV $7,000, basis $6,000). The partners' relative interest in the Sec. 751 assets do not change as a
result of the current distribution. His basis in the land is
A) $5,000.
B) $6,000.
C) $7,000.
D) $10,000.
Answer: B
Explanation: B)
Predistribution basis
$30,000
Minus: cash
( 6,000)
unrealized receivables
( 10,000)
inventory
( 4,000)
Basis available for land
$10,000
Carryover basis of land
$ 6,000
Page Ref.: C:10-4
Objective: 1

21) Danielle has a basis in her partnership interest of $12,000. She receives a current distribution of $8,000
cash and equipment with a basis of $7,000. There is no potential gain under Sec. 737. What is her basis in
the equipment?
A) $0
B) $4,000
C) $7,000
D) none of the above
Answer: B
Page Ref.: C:10-4
Objective: 1

22) Identify which of the following statements is true.

A) If a partnership asset with a deferred precontribution gain is distributed in a nonliquidating
distribution to the partner who contributed the asset, the precontribution gain must be recognized by the
partner.
B) The partner's basis in the partnership interest is normally reduced by the FMV of property distributed
in a nonliquidating distribution.
C) When a current distribution from a partnership reduces the basis of the partnership interest to zero,
the partner's interest in the partnership is terminated.
D) All of the above are false.
Answer: D
Page Ref.: C:10-4 through C:10-7
Objective: 1

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23) Tenika has a $10,000 basis in her interest in the TF Partnership and no remaining precontribution gain
immediately before receiving a current distribution that consisted of $4,000 in money, plastic tubes held in
inventory with a $3,000 basis to the partnership and an FMV of $3,375, and drip irrigation pipe held as
inventory with a $6,000 basis to the partnership and an FMV of $5,000. What is the basis in Tenika's hands
of the distributed property?
A) $10,000
B) $6,000
C) $9,000
D) $10,125
Answer: B
Explanation: B)
Predistribution basis in partnership interest
$10,000
Minus: money received
( 4,000)
Plus: Sec. 737 gain
0
Amount to be allocated
$ 6,000
Page Ref.: C:10-5; Example C:10-7
Objective: 1

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24) Tenika has a $10,000 basis in her interest in the TF Partnership and no remaining precontribution gain
immediately before receiving a current distribution that consisted of $4,000 in money, plastic tubes held in
inventory with a $3,000 basis to the partnership and an FMV of $3,375, and drip irrigation pipe held as
inventory with a $6,000 basis to the partnership and an FMV of $5,000. What is Tenika's basis for the
plastic tubes and drip irrigation pipe?
A)
Plastic Tubes
3,375

Drip Pipe
$5,000

B)
Plastic Tubes
$3,000

Drip Pipe
$6,000

C)
Plastic Tubes
$3,000

Drip Pipe
$5,000

D)
Plastic Tubes
$2,250

Drip Pipe
$3,750

Answer: D
Explanation: D)
FMV of Asset
- Partner basis
Difference
Step 1: Basis
- Toby basis
Increase to allocate
Step 2: Basis
Allocate decline in value
Step 3: Allocate

Plastic Tube
$3,375
3,000
375
$3,000

$3,000
$3,000
( 750)*
$2,250

Drip Pipe
$5,000
6,000
( 1,000)
$6,000

$6,000
(1,000)
$5,000
( 1,250)**
$3,750

Total
$8,375
9,000
( 625)
$9,000
6,000
$3,000
$9,000
( 1,000)
$8,000
( 2,000)
$6,000

*$3,000 ($3,000 + $5,000) 2,000 = 750

**$5,000 ($3,000 + $5,000) 2,000 = 1,250
Page Ref.: C:10-5; Example C:10-7
Objective: 1

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25) The total bases of all distributed property in the partner's hands following a nonliquidating
distribution is limited to
A) the partner's predistribution basis in his partnership interest.
B) the FMV of the property distributed.
C) the partnership's bases in the distributed property.
D) the predistribution FMV of the partner's partnership interest.
Answer: A
Page Ref.: C:10-6
Objective: 1

26) Carlos has a basis in his partnership interest of $30,000. He receives a current distribution of $6,000
cash, unrealized receivables (FMV $11,000, basis $10,000), inventory (FMV $8,000, basis $4,000), land held
as an investment (FMV $7,000, basis, $6,000), and building (FMV $21,000, basis $9,000). The partners'
relative interests in the Sec. 751 assets do not change as a result of the current distribution. Carlos's basis
in the building is
A) $2,500.
B) $6,000.
C) $7,500.
D) $9,000.
Answer: B
Explanation: B)
Basis
$30,000
Minus: cash
( 6,000)
$24,000
Minus: unrealized receivables
( 10,000)
inventory
( 4,000)
Basis to be allocated to land and building
$10,000
[$9,000/($9,000 + $6,000)] $10,000 = $6,000
Page Ref.: C:10-6
Objective: 1

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27) Bart has a partnership interest with a $32,000 basis. He receives a current distribution of $6,000 cash,
unrealized receivables (FMV $9,000, basis $10,000), inventory (FMV $8,000, basis $4,000), investment land
(FMV $7,000, basis $4,000), and building (FMV $20,000, basis $8,000). No depreciation recapture applies
with respect to the building. The partners' relative interests in the Sec. 751 assets do not change as a result
of the current distribution. Bart's basis in the building is
A) $3,000.
B) $4,000.
C) $6,000.
D) $8,000.
Answer: D
Explanation: D)
Predistribution basis
$32,000
Minus: cash
( 6,000)
receivables
(10,000)
inventory
( 4,000)
Basis available for land and building*
$12,000
$12,000 = $8,000 basis for building*
Page Ref.: C:10-6
Objective: 1

28) Identify which of the following statements is true.

A) The basis for property distributed by a partnership cannot be increased above the carryover basis
amount when it is received by a partner in a nonliquidating distribution.
B) A partner's partnership capital account balance cannot be less than zero.
C) The length of time a partner owns a partnership interest is relevant when determining the holding
period for distributed property.
D) All of the above are false.
Answer: A
Page Ref.: C:10-7
Objective: 1

29) Identify which of the following statements is true.

A) If a partner sells property received in a partnership distribution for a gain and the property was
inventory in the hands of the distributing partnership, the partner will always recognize ordinary income.
B) The primary purpose of Sec. 751 is to prevent partnerships from converting capital gains into ordinary
income.
C) Unrealized receivables include rights to payments on the sale of a capital asset.
D) All of the above are false.
Answer: D
Page Ref.: C:10-7 and C:10-8
Objective: 2

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30) Identify which of the following statements is true.

A) The depreciation recapture potential for a Sec. 1245 property is not included in the definition of a Sec.
751 asset.
B) For Sec. 751 purposes, "substantially appreciated inventory" means property held for sale to customers
whose market value exceeds its adjusted basis.
C) Inventory for Sec. 751 purposes includes all property except cash, capital assets, and Sec. 1231 assets
assets.
D) All of the above are false.
Answer: C
Page Ref.: C:10-8
Objective: 2

31) For purposes of Sec. 751, inventory includes all of the following except
A) capital assets or 1231 property.
B) items held for sale in the ordinary course of business.
C) accounts receivable.
D) All of the above are inventory per Sec. 751.
Answer: A
Page Ref.: C:10-8
Objective: 2

32) The AB Partnership has a machine with an FMV of $25,000 and a basis of $20,000. The partnership has
taken an $8,000 depreciation on the machine. The unrealized receivable related to the machine is
A) $0.
B) $5,000.
C) $8,000.
D) $20,000.
Answer: B
Page Ref.: C:10-8; Example C:10-10
Objective: 2

33) The Internal Revenue Code includes which of the following assets in the definition of Sec. 751
properties?
A) inventory, which is substantially appreciated
B) cash
C) capital assets
D) Sec. 1231 assets
Answer: A
Page Ref.: C:10-8
Objective: 2

34) The definition of "inventory" for purposes of Sec. 751 includes

A) cash.
B) land held for investment.
C) marketable securities not held by dealers.
D) depreciation recapture potential on Sec. 1231 assets.
Answer: D
Page Ref.: C:10-8
Objective: 2

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35) The definition of "unrealized receivable" does not include the

A) right to payment for services performed by a cash-basis taxpayer.
B) recapture potential on Sec. 1245 property.
C) recapture potential on Sec. 1250 property.
D) right to payment for services performed by an accrual-basis taxpayer.
Answer: D
Page Ref.: C:10-8
Objective: 2

36) What is the definition of "substantially appreciated inventory"?

A) inventory with a FMV greater than its basis
B) inventory and unrealized receivables with a FMV greater than their basis
C) inventory with a FMV greater than 120% of its basis
D) inventory and unrealized receivables with a FMV greater than 120% of their basis
Answer: D
Page Ref.: C:10-8
Objective: 2

37) The ABC Partnership owns the following assets on December 31.

Cash
Unrealized receivables
Inventory
Land (Sec. 1231 asset)

Basis
$20,000
0
$20,000
50,000

FMV
$20,000
40,000
30,000
90,000

The indication that ABC owns substantially appreciated inventory is

A) the total FMV of all assets except cash is greater than their total basis.
B) the FMV of all assets except land is $90,000 while their bases is $40,000.
C) the FMV of the inventory is $30,000 while its adjusted basis is $20,000.
D) the FMV of the inventory and unrealized receivables is $70,000 while their adjusted bases is $20,000.
Answer: D
Page Ref.: C:10-8 and C:10-9; Example C:10-11
Objective: 2

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38) The XYZ Partnership owns the following assets on December 31:

Cash
Unrealized receivables
Inventory
Land (Sec. 1231 asset)

Basis
$20,000
0
$30,000
40,000

FMV
$20,000
15,000
35,000
70,000

By how much must XYZ reduce its unrealized receivables to avoid meeting the substantially appreciated
inventory test?
A) $10,000
B) $14,000
C) $15,000
D) No amount of reduction of unrealized receivables will affect meeting the substantially appreciated
inventory test.
Answer: B
Explanation: B) ($15,000 + $35,000) - (120% $30,000) = $14,000
Page Ref.: C:10-8 and C:10-9; Example C:10-11
Objective: 2

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39) The XYZ Partnership owns the following assets on December 31:

Cash
Unrealized receivables
Inventory

Basis
$10,000
0
$25,000

FMV
$10,000
10,000
30,000

A partner has a 20% interest with a basis of $6,000 in XYZ before receiving a liquidating distribution of
$10,000 cash. XYZ Partnership has no liabilities. His recognized gain is
A) $4,000 capital gain.
B) $3,000 capital gain and $1,000 ordinary income.
C) $3,000 ordinary income.
D) $3,000 ordinary income and $1,000 capital gain.
Answer: D
Explanation: D) The partner's recognized gain is made up of two components: (1) the amount by which
the proceeds of the deemed sale of the Sec. 751 assets (receivables and inventory) exceeds the basis for
such property when received by the partner in a current distribution, and (2) the amount by which the
remainder of the distribution exceeds the remainder of the partner's basis in the partnership interest.
(1) FMV of receivables and inventory [0.20 ($10,000 + $30,000)]
Minus: basis of receivables and inventory if they
had been distributed in a current distribution
[0.20 (0 + $25,000)]
Ordinary income recognized
(2) Predistribution basis
Minus: basis of Sec. 751 assets deemed distributed
Remaining basis in partnership interest
Minus: cash distributed after Sec. 751 transaction
Excess distribution and capital gain

$8,000

( 5,000)
$3,000
$6,000
( 5,000)
$1,000
( 2,000)
$1,000

Page Ref.: C:10-10 and C:10-11

Objective: 2

40) Identify which of the following statements is true.

A) A liquidating distribution that terminates a partnership interest cannot include more than one
distribution.
B) A partnership with a large amount of unrealized receivables and substantially appreciated inventory
items liquidated and distributed all of its assets in kind to each partner in proportion to their partnership
interests. Each partner will report ordinary income at the time these assets are received equal to their
FMV.
C) The rule for recognizing gain on a liquidating distribution is the same rule that is used for a current
distribution.
D) All of the above are false.
Answer: C
Page Ref.: C:10-12
Objective: 3

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41) Identify which of the following statements is true.

A) When unrealized receivables are distributed in a liquidating distribution, the basis of the receivables
will be increased.
B) The bases of unrealized receivables and inventory distributed by a partnership in liquidation of a
partnership interest are never increased above their bases in the hands of the partnership.
C) The basis of the partnership interest is apportioned between all of the assets received in a liquidating
distribution based on the relative FMVs of the assets.
D) All of the above are false.
Answer: B
Page Ref.: C:10-12
Objective: 3

42) Ted King's basis for his interest in the Troy Partnership is $24,000. In complete liquidation of his
interest, King receives cash of $4,000 and real property (not a Sec. 751 asset) having an FMV of $40,000.
Troy's adjusted basis for this realty is $15,000. Section 736 does not apply. King's basis for this realty is
A) $15,000.
B) $20,000.
C) $36,000.
D) $40,000.
Answer: B
Explanation: B)
Predistribution basis
$24,000
Minus: cash received
( 4,000)
Basis to partner
$20,000
Page Ref.: C:10-12
Objective: 3

43) Derrick's interest in the DEF Partnership is liquidated when his basis in the interest is $30,000. He
receives a liquidating distribution of $20,000 cash and inventory with a basis of $8,000 and an FMV of
$30,000. Derrick will recognize
A) no gain or loss.
B) $2,000 capital loss.
C) $2,000 ordinary loss.
D) $10,000 capital loss and $20,000 ordinary loss.
Answer: B
Page Ref.: C:10-12; Example C:10-15
Objective: 3

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44) Before receiving a liquidating distribution, Kathy's basis in her interest in the KLM Partnership is
$30,000. The distribution consists of $5,000 in money, inventory having a $1,000 basis to the partnership
and a $2,000 FMV, and two parcels of undeveloped land (not held as inventory) having basis of $3,000 and
$9,000 to the partnership with FMVs of $5,000 and $12,000, respectively. What is Kathy's basis in each
parcel of land?
A)
Parcel One
$5,000

Parcel Two
$12,000

B)
Parcel One
$3,000

Parcel Two
$9,000

C)
Parcel One
$7,059

Parcel Two
$16,941

D)
Parcel One
$6,000

Parcel Two
$18,000

Answer: C
Explanation: C) Basis allocated to parcels = $30,000 - $5,000 - $1,000 = $24,000

FMV
- Partnership basis
Difference
Step 1: Basis
- Kathy's basis
Increase to allocate
Step 2: Basis after Step 1
Allocate appreciation difference
Adjusted Basis - Step 2
Step 3: Allocate remainder
Kathy's basis in parcels

Parcel One
$5,000
( 3,000)
$2,000
$3,000

Parcel Two
$12,000
( 9,000)
$ 3,000
$ 9,000

$3,000

$ 9,000

2,000
$5,000
2,059*
$7,059

3,000
$12,000
4,941**
$16,941

Total
$17,000
( 12,000)
$ 5,000
$12,000
(24,000)
$12,000
$12,000
5,000
$17,000
7,000
$24,000

*$5,000 ($5,000 + $12,000) 7,000 = 2,059

**$12,000 ($5,000 + $12,000) 7,000 = 4,941
Page Ref.: C:10-13 and C:10-14; Example C:10-17
Objective: 3

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45) Ten years ago, Latesha acquired a one-third interest in Dana Associates, a partnership, for $26,000
cash. This year, Latesha's entire interest in the partnership is liquidated when her basis is $24,000. Dana's
assets consist of the following: cash, $20,000; inventory with a basis of $46,000 and an FMV of $40,000.
Dana has no liabilities. Latesha receives the cash of $20,000 in liquidation of her entire interest. What is
Latesha's recognized loss on the liquidation of her interest in Dana?
A) $0
B) $4,000 long-term capital loss
C) $4,000 short-term capital loss and $2,000 ordinary loss
D) $4,000 long-term capital loss and $2,000 ordinary loss
Answer: B
Explanation: B)
Predistribution basis
$24,000
Minus: liquidating distribution
( 20,000)
Long-term capital loss
$ 4,000
Page Ref.: C:10-14
Objective: 3

46) Identify which of the following statements is true.

A) On December 31 of the current year, Max Curcio's adjusted basis for his interest in the Maduro &
Motta Partnership is $36,000. Maduro & Motta distributes cash of $6,000 and a parcel of land held as an
investment to Curcio in liquidation of his entire interest in the partnership. The land has an adjusted basis
of $18,000 to the partnership and an FMV of $42,000. Curcio's basis in the land is $18,000.
B) Jake has a basis in his partnership interest of $40,000 before receiving a liquidating distribution of
$5,000 cash, inventory with a basis of $4,000 and an FMV of $5,000, and land with a basis of $3,000 and an
FMV of $6,000. Jake will receive no further distributions. He can recognize a loss of $28,000 at the time the
liquidating distribution is received.
C) A partner's holding period for a partnership interest is never considered when determining the
holding period for property distributed in a liquidating distribution.
D) All of the above are false.
Answer: C
Page Ref.: C:10-14
Objective: 3

47) Identify which of the following statements is false.

A) On June 30 of the current year, James Roe sells his interest in the Roe & Doe Partnership for $30,000.
Roe's adjusted basis in Roe & Doe at June 30 is $7,500 before apportionment of any partnership income for
the current year. The Roe & Doe Partnership uses the calendar year as its tax year and has no liabilities on
June 30. Roe's distributive share of partnership income up to June 30 is $22,500. Roe acquired his interest
in the partnership five years ago. Roe will have a long-term capital gain on the sale of his interest of
$22,500.
B) Section 751 assets include all inventory and all unrealized receivables in a sale or exchange situation.
C) When a partnership interest is sold, the buyer and seller can allocate the sale price among the Sec. 751
assets and non-Sec. 751 assets in any reasonable manner.
D) Statements B and C are true.
Answer: A
Page Ref.: C:10-16 and C:10-17
Objective: 3

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48) Kenya sells her 20% partnership interest having a $28,000 basis to Ebony for $40,000 cash. At the time
of the sale, the partnership has no liabilities and its assets are as follows:

Cash
Unrealized receivables
Inventory
Land (Sec. 1231)

Basis
$20,000
0
10,000
110,000

FMV
$20,000
40,000
40,000
100,000

Kenya and Ebony have no agreement concerning the allocation of the sales price. Ordinary income
recognized by Kenya as a result of the sale is
A) $6,000.
B) $12,000.
C) $14,000.
D) $16,000.
Answer: C
Explanation: C)
Total
Sec. 751 Assets
Non-Sec. 751 Assets
Amount realized
$40,000
$16,000
$24,000
Minus: adjusted
basis
(28,000)
(2,000)
(26,000)
Recognized
$12,000
$14,000
($2,000)
gain/loss
Ordinary income
Capital loss
Page Ref.: C:10-17 and C:10-18; Example C:10-20
Objective: 3

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49) Steve sells his 20% partnership interest having a $28,000 basis to Nancy for $40,000 cash. At the time of
the sale, the partnership has no liabilities and its assets are as follows:

Cash
Unrealized receivables
Inventory
Land (Sec. 1231)

Basis
$20,000
0
10,000
110,000

FMV
$20,000
40,000
40,000
100,000

The receivables and inventory are Sec. 751 assets. There is no agreement concerning the allocation of the
sales price. Steve must recognize
A) no gain or loss.
B) $12,000 ordinary income.
C) $12,000 capital gain.
D) $14,000 ordinary income and $2,000 capital loss.
Answer: D
Explanation: D)
Total
Sec. 751 Assets
Non-Sec. 751 Assets
Amount realized
$40,000
$16,000
$24,000
Minus: adjusted
basis
(28,000)
(2,000)
(26,000)
Recognized
$12,000
$14,000
($2,000)
gain/loss
Ordinary income
Capital loss
Page Ref.: C:10-18; Example C:10-21
Objective: 3

50) Identify which of the following statements is true.

A) John Albin is a retired partner of Brill & Crum, a personal service partnership. Albin has not rendered
any services to Brill & Crum since his retirement six years ago. Under the provisions of Albin's retirement
agreement, Brill & Crum is obligated to pay Albin 10% of the partnership's net income each year through
the end of the current year. In compliance with the agreement, Brill & Crum pay Albin $25,000 in the
current year. Albin should treat this $25,000 as a long-term capital gain.
B) An exchange of partnership interests in different partnerships qualifies under the like-kind exchange
rules.
C) The payment for partnership property to a retiring partner is not deductible by the partnership and
often not income to the retiring partner.
D) All of the above are false.
Answer: C
Page Ref.: C:10-19
Objective: 4

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51) For tax purposes, a partner who receives retirement payments ceases to be regarded as a partner
A) on the last day of the taxable year in which the partner retires.
B) on the last day of the month in which the partner retires.
C) on the day on which the partner retires.
D) only after the partner's last payment is received.
Answer: D
Page Ref.: C:10-20
Objective: 4

52) If a partnership chooses to form an LLC, under the check-the-box rules, and assuming no elections are
made, the entity will be taxed as
A) a partnership if it has more than one member.
B) an S corporation.
C) a C corporation.
D) Unable to determine from the facts presented.
Answer: A
Page Ref.: C:10-21
Objective: 4

53) Identify which of the following statements is true.

A) Under the check-the-box rules, an LLC with more than one member is taxed as a corporation unless it
elects to be taxed as a partnership.
B) The partnership's tax year closes with respect to a partner whose interest is transferred by gift.
C) An LLC has been taxed as a partnership for five years. Under the check-the-box rules, the LLC makes a
timely election in 2009 to be taxed as a C corporation. The election of C corporation status is permitted
and results in the LLC's assets being transferred from a partnership to a C corporation under the federal
income tax rules.
D) All of the above are false.
Answer: C
Page Ref.: C:10-21
Objective: 4

54) If a partner dies, his or her tax year closes

A) on the date of death.
B) on the day after death.
C) on the day before death.
D) on some other date.
Answer: A
Page Ref.: C:10-22
Objective: 4

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55) A partnership terminates for tax purposes

A) only when it terminates under local partnership law.
B) when at least 50% of the total interest in partnership capital and profits changes hands by sale or
exchange within twelve consecutive months.
C) when the sale of partnership assets is made only to an outsider(s) and not to an existing partner(s).
D) when a partnership tax return (Form 1065) ceases to be filed by the partnership.
Answer: B
Page Ref.: C:10-22
Objective: 4

56) Marc is a calendar-year taxpayer who owns a 30% capital and profits interest in the MN Partnership.
Nancy sells the remaining 70% capital and profits interest to Henry on October 31. The partnership yearend is March 31 as permitted by the IRS for business purpose reasons. The MN Partnership
A) terminates on March 31.
B) terminates on October 31.
C) terminates on December 31.
D) does not terminate.
Answer: B
Page Ref.: C:10-22
Objective: 4

57) A partnership terminates for federal income tax purposes if

A) a general partner who owns a majority interest dies.
B) state partnership law terminates the partnership.
C) a partnership interest of more than 50% is gifted.
D) within a 12-month period there is a sale or exchange of at least 50% of the total interest in partnership
capital and profits.
Answer: D
Page Ref.: C:10-22 and C:10-23
Objective: 4

58) Identify which of the following statements is true.

A) The partnership tax year closes when a partner transfers his interest by gift.
B) If a partner dies in a two-member partnership, the partnership terminates on the date of death, even
though the successor-in-interest continues to share in the profits and losses of the partnership business.
C) When the interest of a partner who owns 60% of a partnership is completely liquidated by a
partnership distribution, the partnership is considered terminated, even though three other partners
remain.
D) All of the above are false.
Answer: D
Page Ref.: C:10-22 and C:10-23
Objective: 4

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59) Identify which of the following statements is false.

A) A sale or exchange of at least 50% of the capital and profits interest in a partnership within a 12consecutive-month period will terminate the partnership and end all of the partnership's elections.
B) When using the 50% rule to terminate a partnership, if an interest is sold more than once during the
12-month period, each sale is counted separately.
C) A partner's individual income tax return, under some circumstances, may include the results of
partnership operations for a period exceeding 12-months.
D) When several different transfers are made during a 12-month period, the partnership termination
occurs on the date of the transfer that first crosses the 50% threshold.
Answer: B
Page Ref.: C:10-22 and C:10-23
Objective: 4

60) Sally is a calendar-year taxpayer who owns a 30% capital and profits interest in the SEM
Partnership. Eric sells the remaining 70% capital and profits interest to Michelle on October 3. The
partnership year-end is March 31 as permitted by the IRS for business purposes. Which of the following
statements is correct?
A) Sally must conform her tax year with the partnership tax year.
B) The new partnership is a continuation of the old partnership.
C) Sally's tax return will include a partnership distributive share only for the period ending March 31.
D) Sally's tax return will include partnership distributive shares for periods ending March 31 and October
3.
Answer: D
Page Ref.: C:10-23 and C:10-24
Objective: 4

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61) The LM Partnership terminates for tax purposes on July 15 when Latasha sells her 60% capital and
profits interest to Zoe for $100,000. The partnership has no liabilities, and its assets at the time of
termination are as follows:
Assets
Cash
Receivables
Inventory
Building
Land
Total

Basis
$ 20,000
10,000
22,000
80,000
30,000
$162,000

FMV
$ 20,000
12,000
28,000
85,000
21,667
$166,667

Marika, a 40% partner in the LM Partnership, has a $64,800 basis in her partnership interest (outside
basis) at the time of the termination. She has held her LM Partnership interest for three years at the time
of the termination. The bases of Marika and Zoe in the new LM Partnership is:
A)
Marika
$64,800

Zoe
$ 97,200

B)
Marika
$66,667

Zoe
$100,000

C)
Marika
$64,800

Zoe
$100,000

D)
Marika
$66,667

Zoe
$ 97,200

Answer: C

Page Ref.: C:10-24; Example C:10-28

Objective: 4

62) The AB, BC, and CD Partnerships merge into the ABCD Partnership. AB (owned by Austin and Ben)
contributes assets worth $100,000. BC (owned by Ben and Charlie) contributes assets worth $200,000. CD
(owned by Charlie and Dennis) contributes assets worth $300,000. The capital and profits interest in
ABCD is owned by: Austin, 10%; Ben, 30%; Charlie, 25%; and Dennis, 35%. ABCD Partnership is a
continuation of
A) AB.
B) BC.
C) CD.
D) none of the partnerships.
Answer: C
Page Ref.: C:10-25; Example C:10-30

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Objective: 4

63) Han purchases a 25% interest in the CHOP Partnership from Huang for $600,000. The partnership has
assets with a basis of $1,600,000. What is the amount of the basis adjustment, if the partnership has a 754
election in place?
A) $0
B) $150,000 increase in Han's basis in his partnership interest
C) $200,000 increase in Han's share of the basis in partnership assets
D) $1,000,000 increase in partnership assets
Answer: C
Page Ref.: C:10-26
Objective: 5

64) Patrick purchases a one-third interest in the PPP partnership for $600,000. The partnership has assets
with a value of $1,500,000. PPP has a 754 election in effect. What is the amount of the basis adjustment?
A) $0
B) $300,000 increase in the basis of partnership assets
C) $100,000 increase in Patrick's basis in the partnership assets
D) $100,000 increase in Patrick's share of the basis in the partnership assets
Answer: D
Page Ref.: C:10-26
Objective: 5

65) Which of the following statements is correct?

A) A partnership may make an annual election to adjust the basis of its assets upon the sale of a
partnership interest.
B) The Sec. 754 election applies to both sales and distributions.
C) The Sec. 754 election applies to only current and nonliquidating distributions.
D) A partnership can revoke a Sec. 754 election every 5 years.
Answer: B
Page Ref.: C:10-26 and C:10-27
Objective: 5

66) Which of the following is valid reason for making a 754 election?
A) An incoming partner pays more for a partnership interest that his or her proportionate share of
partnership assets.
B) Partners are able to increase their basis in the partnership interest upon the sale of a partnership
interest.
C) Partnerships can increase, but not decrease, their basis in partnership assets.
D) A partnership can reduce its basis in assets upon cash distributions to partners.
Answer: A
Page Ref.: C:10-27
Objective: 5

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67) Patrick purchased a one-third interest in the PPP partnership for $600,000. At the time of the purchase,
the partnership had a 754 election in effect and its only asset was land with a basis of $1,500,000. This
year, PPP sells the land for $1,800,000. What is Patrick's recognized share of the gain on the sale of the
land?
A) $0
B) $100,000
C) $300,000
D) none of the above
Answer: A
Explanation: A) $1,800,000 - 1,500,000 = 300,000 gain. Patrick's share of the gain is $100,000, which is
offset by the $100,000 754 adjustment. The 754 adjustment is 600,000 purchase price - (1,500,000/3) =
100,000.
Page Ref.: C:10-27; Example C:10-33
Objective: 5

68) When must a partnership make mandatory basis adjustments?

A) on any sale of a 20% or greater partnership interest
B) on any sale of a partnership interest for $250,000 or more
C) on any distribution of assets with a value of $250,000 or more
D) on any sale of a partnership interest where the partnership's adjusted basis in its assets exceeds their
fair market value by $250,000 or more
Answer: D
Page Ref.: C:10-27
Objective: 4

69) Identify which of the following statements is true.

A) When a partnership is divided into two or more new partnerships, all of the resulting partnerships
must be considered new partnerships.
B) A partnership is "publicly traded" only if its interests are traded on an established securities exchange.
C) A limited liability company is a form of business entity that combines the legal benefits of the
corporate form with the tax benefits of the partnership form.
D) All of the above are false.
Answer: C
Page Ref.: C:10-29 through C:10-32
Objective: 6

70) The STU Partnership, an electing Large Partnership, has no passive activities and reports the following
transactions for the year: net long-term capital losses $50,000, Sec. 1231 gain $60,000, ordinary income
$20,000, charitable contributions $15,000, and tax-exempt income $2,000. How much will be reported as
ordinary income to its partners?
A) $5,000
B) $17,000
C) $20,000
D) $22,000
Answer: B
Explanation: B) [$20,000 - 10% (10,000 + 20,000)] = $17,000
Page Ref.: C:10-32
Objective: 6

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71) The STU Partnership, an electing Large Partnership, has no passive activities and reports the following
transactions for the year: net long-term capital losses $50,000, Sec. 1231 gain $60,000, ordinary income
$20,000, charitable contributions $15,000, and tax-exempt income $2,000. How much will be reported as
long-term capital gains to its partners?
A) $0
B) $10,000
C) $50,000
D) $60,000
Answer: B
Page Ref.: C:10-32
Objective: 6

72) Two years ago, Tom contributed investment land with a basis of $50,000 and FMV of $62,000 to the
RST Partnership. This year, Tom has a basis in his partnership interest of $53,000 when he receives a
current distribution of $14,000 cash and inventory with a basis of $35,000 and FMV of $52,000. (There is
no Sec. 751 exchange in connection with the inventory distribution.) The partnership continues to hold the
land Tom contributed. How much gain (if any) must Tom recognize as a result of this distribution?
Answer: Precontribution gain = $62,000 - $50,000 = $12,000
Predistribution basis
Minus: cash distribution

$53,000
( 14,000)
$39,000

Minus: FMV of distribution other than cash

Tentative Sec. 737 gain

( 52,000)
$13,000

Recognized gain = $12,000 [the smaller of precontribution gain ($12,000) or tentative Sec. 737 gain
($13,000)].
Page Ref.: C:10-3; Example C:10-3
Objective: 1

73) On November 30, Teri received a current distribution of cash of $4,000, marketable securities with a
basis of $24,000 and an FMV of $30,000, and inventory with a basis of $2,000 and an FMV of $6,000. Prior
to the distribution, Teri's basis in her interest in the partnership was $30,000. (There is no Sec. 751
exchange as a result of the distribution.) How much gain (if any) must Teri recognize as a result of the
distribution?
Answer:
Predistribution basis
$30,000
Minus: money received (cash and FMV of marketable securities)
(34,000)
Gain recognized
$ 4,000
Page Ref.: C:10-3
Objective: 1

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74) Jerry has a $50,000 basis for his interest in JJ Partnership before receiving a current distribution
consisting of $8,000 in money, accounts receivable having a zero basis to the partnership, and land having
a $28,000 basis to the partnership. What will Jerry's basis be in these assets?
Answer: Generally, the partner's basis for property distributed by the partnership carries over from the
partnership. Jerry will take the carryover basis in the land and receivables.
Page Ref.: C:10-4; Example C:10-6
Objective: 1

75) Jerry has a $50,000 basis for his interest in JJ Partnership before receiving a current distribution
consisting of $8,000 in money, accounts receivable having a zero basis to the partnership, and land having
a $28,000 basis to the partnership. What is Jerry's basis in his partnership interest after the distribution?
Answer:
Predistribution basis in JJ
$50,000
Minus: money received
( 8,000)
carry over basis in A/R
(0)
carry over basis in land
(28,000)
Postdistribution basis in JJ
$14,000
Page Ref.: C:10-4; Example C:10-6
Objective: 1

76) Last year, Cara contributed investment land with an FMV of $24,000 and basis of $18,000 to the CDE
Partnership. CDE made no distributions during last year, and Cara's basis in her partnership interest on
December 31 of last year was $28,000. On January 1 of this year, the partnership distributed cash of
$30,000 to Cara and distributed the land contributed by Cara to another partner, David. On the
distribution date, the land had a $27,000 FMV. Assume the CDE Partnership reported no profit or loss this
year. How much gain (if any) must Cara recognize as a result of the distributions? What is her basis in the
partnership after the distributions?
Answer: Cara must recognize a $6,000 capital gain ($24,000 FMV at contribution - $18,000 basis at
contribution) on the distribution of the land to David. The gain recognized increases Cara's basis in her
partnership interest.
Cara's predistribution basis
Plus: precontribution gain recognized

$28,000
6,000
$34,000

Minus: cash distribution

Cara's basis after distribution

( 30,000)
$ 4,000

No income is recognized as a result of the cash distribution.

Page Ref.: C:10-5 and C:10-11
Objective: 2

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77) The TK Partnership has two assets: $20,000 cash and a machine having a $28,000 basis and a $40,000
FMV. The partnership has claimed $16,000 in depreciation on the machine since its purchase. If the
machine is sold for its FMV, would TK Partnership have an unrealized receivable item?
Answer: Yes. All of the $12,000 gain would be an unrealized receivable, since it is recaptured under Sec.
1245. Primary examples of unrealized receivables are the potential ordinary income recapture items like
Sec. 1245 or Sec. 1250.
Page Ref.: C:10-8 and C:10-9; Example C:10-11
Objective: 2

78) The Tandy Partnership owns the following assets on December 31:
Assets
Cash
Unrealized receivables
Inventory
Land, Sec. 1231 property
Total

Basis
$20,000
0
20,000
35,000
$75,000

Fair Market Value

$ 20,000
30,000
25,000
70,000
$145,000

Is the partnership's inventory considered to be substantially appreciated for purposes of Sec. 751? Show
your work.
Answer: For purposes of the substantially appreciated inventory test, both Tandy's unrealized receivables
and inventory are included. The "inventories" FMV of $55,000 exceeds 120% of its adjusted basis, $20,000.
Therefore, the Tandy Partnership has substantially appreciated inventory.
Page Ref.: C:10-8 and C:10-9; Example C:10-11
Objective: 2

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79) The CHS Partnership's balance sheet presented below is prepared on a cash basis at September 30 of
the current year.
Assets
Cash
Accounts receivable
Land (capital asset)
Total

Basis
$12,000
0
63,000
$75,000

Fair Market Value

$ 12,000
48,000
90,000
$150,000

Equities
Notes payable
Cindy, Capital
Helen, Capital
Sally, Capital
Total

Basis
$30,000
15,000
15,000
15,000
$75,000

Fair Market Value

$ 30,000
40,000
40,000
40,000
$150,000

Cindy withdraws from the partnership under an agreement whereby she takes one-third of each of the
three assets and assumes $10,000 of the notes payable. Her basis for the partnership interest before any
distribution is $25,000. What gain/loss should she report for tax purposes?
Answer: No gain or loss is recognized by Cindy or the partnership on the distribution of the Sec. 751
properties, since Cindy received only her proportionate share of the partnership's assets and liabilities
and the amount of cash deemed distributed ($14,000 = $4,000 cash + $10,000 release from liabilities) is less
than her $25,000 ($15,000 + $10,000 liabilities) basis for the partnership interest.
Page Ref.: C:10-8 through C:10-12
Objective: 3

80) Adnan had an adjusted basis of $11,000 for his interest in the Adnan and Donnell Partnership on
December 31. On this date, Adnan received from the partnership, in complete liquidation of his interest,
$10,000 cash and land with a $2,000 basis to the partnership and a $3,000 FMV. What is Adnan's basis for
the land distributed to him?
Answer: $11,000 - $10,000 cash = $1,000 remaining basis. This basis is assigned to the land.
Page Ref.: C:10-12
Objective: 3

81) Eicho's interest in the DPQ Partnership is terminated when her basis in the partnership is $70,000. She
receives a liquidating distribution of $20,000 cash and inventory with a $24,000 basis and a $40,000 FMV.
What is her gain or loss, and what is her basis in the inventory received?
Answer: She has a recognized loss of $26,000 [($20,000 + $24,000) - $70,000]. Her basis in the inventory
she receives is $24,000.
Page Ref.: C:10-12; Example C:10-15
Objective: 3

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82) Eicho's interest in the DPQ Partnership is terminated when her basis in the partnership is $70,000. She
receives a liquidating distribution of $20,000 cash and inventory with a $24,000 basis and a $40,000 FMV.
She also receives, as part of the distribution, a desk that has a $100 basis and a $200 FMV to the
partnership. What is her gain or loss, and what is her basis in the items received?
Answer: She does not recognize any loss currently. The bases are computed as follows:
Predistribution basis in DPQ
Minus: money received
Basis after money distribution
Minus: basis of inventory to DPQ
Remaining basis of partnership interest

$70,000
( 20,000)
50,000
( 24,000)
$26,000

The entire $26,000 is allocated to the desk. This delays the loss recognition until the desk is either
depreciated or sold.
Page Ref.: C:10-12 and C:10-13; Example C:10-16
Objective: 3

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83) On December 31, Kate receives a $28,000 liquidating distribution from the KLM Partnership. On that
date, Kate's basis in her limited partnership interest is $18,000 (which, of course, includes her share of
partnership liabilities). The other partners assume her $6,000 share of liabilities. Just prior to the
distribution, the partnership has the following balance sheet. Kate is leaving the partnership but the
partnership is continuing.
Assets
Cash
Accounts receivable
Inventory
Land
Total

Basis
$30,000
0
15,000
45,000
$90,000

Fair Market Value

$ 30,000
20,000
25,000
90,000
$165,000

Equities
Notes payable
Kate, capital
Lynn, capital
Mark, capital
Total

Basis
$30,000
12,000
24,000
24,000
$90,000

Fair Market Value

$ 30,000
27,000
54,000
54,000
$165,000

What is the amount and character of the gain that Kate must recognize on the liquidating distribution?
Answer: Divide the payments between Sec. 736(a) and Sec. 736(b) payments.
Total received ($28,000 + $6,000)
Minus: FMV of assets (Sec. 736(b))
Sec. 736(a) payment - guaranteed payment taxable as ordinary income

$34,000
( 33,000)
$ 1,000

Analysis of the Sec. 736(b) payment of $33,000.

Kate is first deemed to receive her share of Sec. 751 assets from the partnership and then immediately sell
them to the partnership for cash.
Sec. 751 Assets
Amount realized - FMV
$ 9,000
Minus: adjusted basis
( 3,000)
Ordinary income
$ 6,000
The remaining Sec. 736(b) payment of $24,000 ($33,000 - $9,000 deemed paid for the Sec. 751 assets) is
analyzed as a liquidating distribution.
Predistribution basis in partnership
Minus: Sec. 751 deemed distribution
Basis in partnership interest after Sec. 751 transaction
Minus: remaining Sec. 736(b) distribution
Excess or capital gain to be recognized

$18,000
( 3,000)
$15,000
( 24,000)
$ 9,000

Summary: Kate recognizes a $1,000 guaranteed payment, $6,000 of ordinary income, and a $9,000 capital
gain.
Page Ref.: C:10-12 through C:10-16

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Objective: 3

84) The HMS Partnership, a cash method of accounting entity, has the following balance sheet at
December 31 of last year:
Assets
Cash
Accounts receivable
Total

Basis
$51,000
0
$51,000

Fair Market Value

$ 51,000
210,000
$261,000

Equities
Notes payable
Henry, capital
Mark, capital
Sam, capital
Total

Basis
$30,000
7,000
7,000
7,000
$51,000

Fair Market Value

$ 30,000
77,000
77,000
77,000
$261,000

Sam, who has a one-third interest in profits, losses, and liabilities, sells his partnership interest to Beverly,
for $77,000 cash on January 1 of this year. Sam's basis in his partnership interest (which, of course,
includes a share of partnership liabilities) at the time of the sale was $17,000. In addition, Beverly assumes
Sam's share of the partnership liabilities. What is the amount and character of the gain that Sam will
recognize from this sale?
Answer: Amount realized = $77,000 +$10,000 liabilities assumed = $87,000.
Realized and recognized gain = $87,000 - $17,000 = $70,000.
The recognized gain is all ordinary income, since it equals his share of the unrealized receivables.
Page Ref.: C:10-16 through C:10-19
Objective: 3

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85) On December 31, Kate sells her 20% interest (with a basis of $18,000 which, of course, includes a share
of partnership liabilities) in the KLM Partnership to Karl for $27,000 cash plus assumption of her $6,000
share of liabilities. On that date, the partnership has the following balance sheet:
Assets
Cash
Accounts receivable
Inventory
Land
Total

Basis
$30,000
0
15,000
45,000
$90,000

Fair Market Value

$ 30,000
20,000
25,000
90,000
$165,000

Equities
Notes payable
Kate, capital
Lynn, capital
Mark, capital
Total

Basis
$30,000
12,000
24,000
24,000
$90,000

Fair Market Value

$ 30,000
27,000
54,000
54,000
$165,000

What are the amount and character of the gain that Kate must recognize on the sale?
Answer:
Total
Sec. 751 Assets
Other
Amount realized
$33,000
$ 9,000
$24,000
Minus: adjusted
( 18,000)
( 3,000)
( 15,000)
basis
$15,000
$ 6,000
$ 9,000
Recognized gain
Ordinary
Capital
Character of gain
Page Ref.: C:10-16 through C:10-18
Objective: 3

86) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the
partnership's assets are as follows:
Assets
Cash
Unrealized receivables
Inventory
Land
Total

Basis
$80,000
0
80,000
80,000
$240,000

Fair Market Value

$ 80,000
72,000
184,000
64,000
$400,000

The partnership has no liabilities on the sale date. Tony's basis in his partnership interest on the date of
the sale is $60,000. What is the amount of gain realized by Tony on the sale of his partnership interest?
Answer:
Amount realized on sale
$100,000
Minus: adjusted basis of partnership interest
( 60,000)
Total gain realized
$ 40,000
Page Ref.: C:10-17 and C:10-18; Example C:10-20
Objective: 3

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87) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the
partnership's assets are as follows:
Assets
Cash
Unrealized receivables
Inventory
Land
Total

Basis
$80,000
0
80,000
80,000
$240,000

Fair Market Value

$ 80,000
72,000
184,000
64,000
$400,000

The partnership has no liabilities on the sale date. Tony's basis in his partnership interest on the date of
the sale is $60,000. What is the allocation of Tony's gain to the assets received?
Answer:
Deemed sale of assets Partnership gain (loss) Tony's share (25%)
Unrealized receivables
72,000
18,000
Inventory
104,000
26,000
Land
( 16,000)
( 4,000)
Page Ref.: C:10-17 and C:10-18; Example C:10-20
Objective: 3

88) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the
partnership's assets are as follows:
Assets
Cash
Unrealized receivables
Inventory
Land
Total

Basis
$80,000
0
80,000
80,000
$240,000

Fair Market Value

$ 80,000
72,000
184,000
64,000
$400,000

The partnership has no liabilities on the sale date. Tony's basis in his partnership interest on the date of
the sale is $60,000. What are the amount and character of Tony's gain?
Answer:
Deemed sale of assets Partnership gain (loss) Tony's share (25%)
Unrealized receivables
72,000
18,000
Inventory
104,000
26,000
Land
( 16,000)
( 4,000)
Since the unrealized receivables and the inventory are Sec, 751 property, Tony recognizes $44,000 of
ordinary income. The remaining $4,000 loss is a capital loss.
Page Ref.: C:10-17 and C:10-18; Example C:10-20
Objective: 3

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89) Joshua is a 40% partner in the XY Partnership when he sells his entire interest to Stanley for $60,000
cash. At the time of the sale, Joshua's basis is $36,000, which includes his $10,000 share of partnership
liabilities. The partnership has no Sec. 751 assets. Calculate Joshua's gain or loss on the sale.
Answer:
Amount realized:
Cash
$60,000
Liabilities assumed by purchaser
10,000
$70,000
Minus: adjusted basis
36,000
Gain recognized on sale
$34,000
Page Ref.: C:10-17 and C:10-18; Example C:10-20
Objective: 3

90) Sean, Penelope, and Juan formed the SPJ partnership by each contributing assets with a basis and fair
market value of $200,000. In the following year, Penelope sold her one-third interest to Pedro for $225,000.
At the time of the sale, the SPJ partnership had the following balance sheet:

Cash
Land

Basis
$200,000
$400,000
$600,000

FMV
$200,000
$475,000
$675,000

Shortly after Pedro became a partner, SPJ sold the land for $475,000. What are the tax consequences of the
sale to Pedro and the partnership (1) assuming there is no Section 754 election in place, and (2) assuming
the partnership has a valid Section 754 election?
Answer: (1) The partnership has a $75,000 gain ($475,000 - $400,000) and $25,000 of this gain is allocated
to Pedro. (2) Pedro's share of the basis of the land is increased by $25,000, the amount that he paid for the
partnership interest in excess of the basis of the partnership assets. This basis increase is allocated entirely
to the land. The partnership still has a $75,000 gain on the sale of the land, but Pedro's $25,000 share is
eliminated by the 754 adjustment to the basis of the land (1/3 475,000) - [(1/3 400,000) + 25,000] = 0.
Page Ref.: C:10-27
Objective: 5

91) What is included in the definition of unrealized receivables?

Answer: Unrealized receivables include not only the obvious cash-method accounts receivable that have
yet to be recognized but also most of the potential ordinary income recapture provisions. Therefore, the
term unrealized receivables is broader than it may appear.
Page Ref.: C:10-8
Objective: 2

92) Do most distributions made by a partnership require a Sec. 751 calculation?

Answer: No. Many current distributions are made pro rate to all partners, so Sec. 751 is not involved.
Even if the distribution is not pro rate, the distribution often does not create an exchange of an interest in
Sec. 751 assets for an interest in other assets. This exchange happens only when (1) the partner is reducing
his or her overall interest in the partnership, or (2) an explicit agreement provides that the distribution
results in a partner giving up all or part of his or her interest in some asset(s) maintained by the
partnership.
Page Ref.: C:10-11
Objective: 2

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93) What conditions are required for a partner to recognize a loss upon receipt of a distribution from a
partnership?
Answer: A partner can recognize a loss on a distribution only if the distribution is a liquidating
distribution that consists of money, unrealized receivables, and inventory. The partner recognizes a loss if
the amount of money and the carryover basis of the receivables and inventory are less than the partner's
predistribution basis in his or her partnership interest.
Page Ref.: C:10-12 and C:10-13
Objective: 3

94) What is the character of the gain/loss on the sale of a partnership interest?
Answer: Because a partnership interest is generally a capital asset, the sale of a partnership interest
results in a capital gain or loss. However, if a partnership has Sec. 751 assets, the partner is assumed to sell
his or her share of Sec. 751 assets directly with a corresponding ordinary gain or loss being recognized.
Page Ref.: C:10-16
Objective: 3

95) Can a partner recognize both a gain and a loss on the sale of a partnership interest? If so, under what
conditions?
Answer: A partner must divide the sale of a partnership interest into two transactions if the partnership
has Sec. 751 assets. First, the partner is deemed to sell his or her share of Sec. 751 assets for their FMV
with their adjusted bases to the partner, being the basis the Sec. 751 assets would have had if the partner
had received them in a current distribution. The remaining sales proceeds and the remaining adjusted
bases are then considered to be the amounts to be reported from the sale of the remainder of the
partnership interest (non-Sec. 751 assets). Possibly, one part of the transaction could generate a loss while
the other part could generate a gain.
Page Ref.: C:10-16 through C:10-19
Objective: 3

96) What are some advantages and disadvantages of making a Section 754 election?
Answer: Advantages: Without a 754 election, if a new partner purchases a partnership interest when the
partnership assets have a fair market value greater than their basis, the partner will be taxed on his/her
proportionate share of any gain on a subsequent sale of these assets in addition to paying a higher
purchase price for the partnership interest due to the assets' appreciation. The partner will not be able to
recover this "double taxation" until the partnership is liquidated, which may be several years in the future.
Sec. 754 prevents this timing problem by adjusting the partner's basis in partnership assets.
The Sec. 754 election has several disadvantages, including increased recordkeeping. Partners and/or the
partnership must maintain separate records showing the calculation and allocation of the basis
adjustment. Once a 754 election is made, adjustments are required on all subsequent sales and
distributions, even if the adjustment decreases the basis. For distributions, the basis adjustment belongs to
the partnership as a whole. The 754 election can only be revoked with IRS approval.
Page Ref.: C:10-26 through C:10-28
Objective: 5

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97) What are the advantages of a firm being formed as a limited liability company (LLC) instead of as a
limited partnership?
Answer: From a legal standpoint, all the owners of a limited liability company (LLC) have limited
liability for the firm's debts. In a limited partnership, all general partners have significant liability for firm
debts. Under the check-the-box regulations, an LLC can choose whether to be taxed as a partnership or as
an association taxed as a corporation. If the LLC chooses partnership taxation, there is virtually no
difference between the taxation of the LLC and the limited partnership.
Page Ref.: C:10-30
Objective: 6

98) The limited liability company (LLC) has become a popular business form because of its limited
liability protection for its owner. The S corporation also provides limited liability protection for its owner.
What advantages does an LLC provide that are not available with an S corporation?
Answer:
The LLC is taxed as a partnership under the check-the-box rules. As such, the basic operating
restrictions that are imposed on an S corporation do not apply to an LLC. These include, but are not
limited to: a 100 shareholder limit; restrictions on the type of eligible shareholders; a single class of stock;
and the limitation on amount of passive income that can be earned by an S corporation.
The corporate-level taxes imposed on an S corporation, such as the built-in gains tax and excess net
passive income tax, do not apply to an LLC.
The loss limitation is larger for an LLC than for an S corporation because of the treatment of general
debts incurred by the LLC under the partnership taxation rules.
All states have enacted LLC laws, so that the problem with a lack of developed legal structure for
handling general legal problems has disappeared. The application of basic legal principles to S
corporations was no problem since in most cases they followed the basic rules for corporations.
Page Ref.: C:10-30
Objective: 6

99) What is an electing large partnership? What are the advantages to the partnership of electing to be
taxed under the electing large partnership rules?
Answer: An electing large partnership is a partnership that is not a service partnership, is not engaged in
commodity trading, has at least 100 partners, and files an election to be taxed as an electing large
partnership. The primary advantage to the partnership of electing to be an electing large partnership is
that the reporting of income to the large number of partners is simplified. Relatively few items are
separately stated so that the reporting process is more difficult than a corporation but easier than a
nonelecting partnership.
Page Ref.: C:10-32 through C:10-34
Objective: 6

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100) All states have adopted laws providing for limited liability companies. Describe a limited liability
company (LLC).
Answer: An LLC often combines the legal benefits of a corporation with the tax benefits of a partnership.
Whether an LLC is characterized as a corporation or a partnership for federal tax purposes depends on
the number of corporate characteristics that are present. An LLC should be treated as a partnership if it
has the centralized management and limited liability characteristics of a corporation, but does not have
the free transferability of interest or continuity-of-life characteristics. If treated as a partnership, they offer
more flexibility than an S corporation in that there is no limit on the number of shareholders, the number
of classes of stock that can be outstanding, or the types of investments in related entities that can be made.
The increased flexibility being written into some of the state LLC laws concerning the various corporate
characteristics has resulted in the LLCs created in certain states being treated as corporations or
partnerships, depending upon the terms of the LLC's organizing document. However, the IRS
implemented a system that allows LLCs to designate via a check-the-box mechanism whether they wish
to be taxed as a partnership or as a corporation. It is anticipated that most new LLCs will desire to be
taxed as a partnership (their default treatment) when they have two or more owners.
Page Ref.: C:10-30
Objective: 6

101) When Rachel's basis in her interest in the RST Partnership is $40,000, she receives a current
distribution of office equipment. The equipment has an FMV of $60,000 and a basis of $50,000. Rachel will
not use the office equipment in a business activity. What tax issues should Rachel consider with respect to
the distribution?
Answer:
Does Rachel recognize a gain or loss on the current distribution?
What is Rachel's basis in the office equipment?
When does Rachel's holding period begin for the property?
Does any depreciation recapture carry over to Rachel from the partnership?
What is Rachel's basis in her partnership interest following the distribution?
Rachel recognizes no gain or loss on the distribution. Her basis for the equipment would be a carryover
basis from the partnership ($50,000) if that were possible, but it is limited to her basis in her partnership
interest prior to the distribution ($40,000). Rachel's holding period for the office equipment includes the
holding period the partnership had for the property. Her basis in the partnership interest is zero
following the distribution.
Page Ref.: C:10-2 through C:10-7
Objective: 1

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102) Ed receives a $20,000 cash distribution from the EV Partnership, which reduces his partnership
interest from one-third to one-fourth. The EV Partnership is a general partnership that uses the cash
method of accounting and has substantial liabilities. EV's inventory has appreciated substantially since it
was purchased. What issues should Ed consider with regard to the distribution?
Answer: Ed must determine:
How much is his distribution?
Does the partnership have Sec. 751 assets?
If the partnership has Sec. 751 assets, did Ed exchange any interest in Sec. 751 assets for cash?
How much ordinary income must Ed recognize if he exchanges Sec. 751 assets for cash?
How must Ed treat any cash distribution received that exceeds the amount deemed to be part of the
Sec. 751 exchange?
The amount of the distribution includes both the cash and the relief from liabilities that he received when
his interest in the partnership changed from 1/3 to 1/4. It is likely that the partnership has Sec. 751 assets,
since we know the partnership inventory is substantially appreciated. Further, it is likely that the cashbasis partnership has unrealized accounts receivable, and the partnership may have recapture potential if
it has any depreciable personalty. Again, it is likely that an exchange of Sec. 751 assets for cash occurred,
since Ed received only cash and probably gave up a portion of his interest (from 1/3 to 1/4) in each Sec.
751 asset. The amount of ordinary income is the difference between the amount of cash Ed is deemed to
have received for the Sec. 751 assets and the adjusted basis that Ed would have had in the Sec. 751 assets
had the Sec. 751 assets been distributed to Ed immediately before the deemed Sec. 751 sale (usually a
carryover from the partnership's basis in these Sec. 751 assets). Any cash or deemed cash exceeding the
amount deemed to be part of the Sec. 751 exchange is simply treated as a current distribution. The current
distribution will reduce his basis in his partnership interest. If the current distribution is greater than his
basis in the partnership interest, Ed will recognize gain because he receives cash exceeding his basis.
Page Ref.: C:10-7 through C:10-11
Objective: 2

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103) David sells his one-third partnership interest to Diana for $60,000 when his basis in the partnership
interest is $48,000. On the date of sale, the partnership has no liabilities and the following assets:
Assets
Cash
Inventory
Building
Land

Basis
$40,000
18,000
75,000
11,000

FMV
$40,000
27,000
102,000
11,000

The building is depreciated on a straight-line basis. What tax issues should David and Diana consider
with respect to the sale transaction?
Answer:
Does the partnership have Sec. 751 assets?
What is the amount and character of the gain on the sale of David's partnership interest?
There are no unrealized receivables, but the partnership does have inventory. David's gain is calculated as
follows:
Assets
Total
Sec. 751
Other
Amount realized
$60,000
$9,000
$51,000
Minus: adjusted basis
(48,000)
(42,000)
Recognized gain
$12,000
$3,000
$ 9,000
The gain attributable to the Sec. 751 assets is ordinary while the remainder of the gain is capital.
Page Ref.: C:10-16 through C:10-19
Objective: 3

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104) Rod owns a 65% interest in the RRR Partnership, a general partnership, which he sells to the two
remaining partners Roger and Regis. The three partners have agreed that Rod will receive $160,000 in
cash from the sale. Rod's basis in the partnership interest before the sale is $125,000, which includes his
$35,000 share of partnership recourse liabilities. The partnership has assets with a $310,000 FMV and a
$210,000 adjusted basis. What issues should Rod, Roger, and Regis consider before this sale takes place?
Answer: Roger and Regis should consider the following:
The sale as contemplated will terminate the partnership. Is termination of the partnership desirable
for Roger and Regis?
Will either individual have to recognize a gain? The recognition of gain is unlikely unless Roger and
Regis have a small basis relative to the cash held by the partnership and deemed distributed in the
liquidating distribution.
What will be the basis for each of the assets? Under current Treasury Regulations, the termination
will be deemed to result in the old partnership contributing the property directly to the new partnership
so that no adjustment to asset bases is likely to occur.
Will income be bunched into a single tax year if the partnership terminates? Termination of the
partnership closes a tax year. If the partnership has the same tax year-end as Roger and Regis, no
bunching of income will occur. If their tax years differ, however, some bunching will occur.
When the partnership terminates, all elections are lost. Are there advantages or disadvantages from
losing all existing elections? There are a few advantageous tax year-ends for old partnerships that were
grandfathered when Congress enacted the rules about required partnership tax year-ends. The loss of this
tax benefit would be a significant disadvantage.
Would liquidation by the partnership be more advantageous than a sale to the other partners?
Liquidation by the partnership cannot terminate the partnership.
Rod should consider:
How much of his gain from the sale would be considered as a sale from his interest in Sec. 751 assets
and, therefore, taxed as ordinary income? His sale will result in ordinary income to the extent the FMV of
Sec. 751 assets exceeds the adjusted basis in those assets that Rod would have had if the assets had been
distributed to Rod just before he sold his interest in the partnership.
Will the sale cause a bunching of income from the partnership for Rod? Since the sale of the entire
partnership interest closes the partnership tax year for the selling partner, the sale will cause bunching of
income if Rod's tax year-end is different from RRR's tax year-end.
Could the transaction be structured in such a way that a liquidation by the partnership would be
more beneficial to Rod? Possibly. If Roger and Regis really do not want the partnership to terminate, they
may be willing to pay Rod more in a liquidating distribution than they were willing to pay for an outright
purchase.
Page Ref.: C:10-16 through C:10-19, C:10-22 through C:10-24
Objective: 4

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105) Quinn and Pamela are equal partners in the QP Partnership. On December 30 of the current year, the
QP Partnership agrees to liquidate Quinn's partnership interest for a cash payment on December 30 of
each of the next five years. What tax issues should Quinn and Pamela consider with respect to the
liquidation of Quinn's partnership interest?
Answer:
Does the partnership terminate for tax purposes?
If so, when does the termination occur?
The partnership terminates since only one partner remains. The partnership terminates when the final
Sec. 736 payment is made.
Page Ref.: C:10-22 and C:10-23
Objective: 4

106) Brown Company recently has been formed as a limited liability company (LLC). Brown Company is
owned equally by three individualsGene, Susan, and Sandraall of whom have substantial income
from other sources. Brown is a manufacturing firm and expects to earn approximately $130,000 of
ordinary income and $30,000 of long-term capital gain each year for the next several years. Gene will be a
full-time manager and will receive a salary of $60,000 each year. What tax issues should the owners
consider regarding the LLC's initial year of operations?
Answer:
Should Brown choose to be taxed as a partnership or as a corporation?
How much will be kept in the business for growth, and how much will be distributed to the owners
each year? The larger the percentage of earnings that will be distributed, the more advantageous a flowthrough entity such as a partnership can be.
What is the marginal tax rate for Gene, Susan, and Sandra? If Gene, Susan, and Sandra have lower
marginal tax rates than does Brown, partnership status has advantages.
How should Gene's pay for operating the business be structured? If the business is taxed as a
corporation, a generous but reasonable salary will decrease the amount of income subject to double
taxation. If the business is structured as a partnership, the partners need to decide whether to structure
the payment as distributive share, as an outright guaranteed payment, or whether to establish a
guaranteed minimum that may be some combination of the two.
Page Ref.: C:10-30
Objective: 6

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107) The Principle Limited Partnership has more than 300 partners and is publicly traded. The Principle
was grandfathered under the 1987 Tax Act and has consistently been taxed as a partnership. In the current
year, The Principle Limited Partnership will continue to be very profitable and will continue to pay out
about 30% of its income to its owners each year. The managing partners of The Principle want to consider
the firm's options for taxation in the current and later years.
Answer: What method should The Principle Limited Partnership choose to use to operate under the
publicly traded partnership rules?
Pay the annual 3.5% of gross income tax and continue to be taxed as a publicly traded partnership?
Buy back enough interests (or restrict opportunities for trading) so that the partnership is no longer
publicly traded?
Incorporate the entity and be taxed as a regular (C) corporation?
The best alternative will be a function of the amount of gross income, amount of taxable income, tax rates
of the partners, amount of profits the firm wants to retain, and costs of buying back partnership interests,
and/or restricting trading, or incorporating.
If The Principle Limited Partnership chooses to continue as a partnership, should it elect to come under
the electing large partnership rules?
The election reduces the partnership's annual cost of providing information to partners but will
require some start-up cost to make the change. The election also has the advantage of making it more
difficult to accidentally terminate the partnership because of trades. However, the election significantly
reduces the partners' reporting and audit options.
Page Ref.: C:10-29
Objective: 6

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