Question

The Callaway Real Estate Limited Partnership (Callaway) was formed on January 1, 2021, to purchase, construct, and manage residential real estate. The partnership adopted the accrual method of accounting and a calendar year for federal tax purposes. On February 2, 2021, Callaway purchased the Berkshire Manor apartment complex for a total price of $5,000,000. $1,000,000 of the purchase price was allocated to the land and $4,000,000 was allocated to the buildings. Callaway financed the acquisition by obtaining a fifteen-year $4,500,000 mortgage from a savings and loan that is unrelated to any of the Callaway partners. The mortgage is secured by the apartment complex but is fully recourse to the partnership. No other properties were purchased during 2021. A summary of partnership operating revenues and expenses for 2021 is attached. In addition to operating revenues and expenses, the partnership also calculated depreciation on the apartment complex for 2021 in the amount of $127,273 ($4,000,000 depreciable basis / 27.5 = $145,455 annual depreciation × 10.5 months / 12 months). The Callaway partnership agreement provides that the corporate general partner, Tambour Properties Inc. (Tambour), will receive an annual management fee equal to 5 percent of the gross rental income earned by the partnership. This fee is reasonable by local industry standards. In return for the fee, Tambour will provide all necessary services so that Callaway will not have to hire any partnership employees. All partnership taxable income, gain, or loss will be allocated 5 percent to Tambour and 95 percent to the limited partners based on each limited partner’s specified percentage interest. The agreement provides that partners’ capital accounts will be determined and maintained in accordance with the Section 704 (b) regulations, and that liquidating distributions will be made in accordance with capital account balances. As general partner, Tambour is required to restore any deficit balance in its capital account upon liquidation; limited partners are not subject to this deficit restoration requirement. However, the partnership agreement does contain a “qualified income offset” to satisfy the alternate test for economic effect of Regulations Section 1.704-1(b)(2)(ii)(d). On January 20, 2021, Dr. Samantha Ashin contributed undeveloped land to Callaway in exchange for a 38 percent limited partnership interest (i.e., Samantha will receive 40 percent of the 95 percent allocations to the limited partners). Tambour, as general partner, agreed to this exchange because the land is ideally situated for future development as residential rental property. Samantha inherited the land a number of years ago and her tax basis in the property is only $125,000; the appraised value of the land at date of contribution was $275,000 and the entry to Samantha’s partnership capital account properly reflected this contributed value. The partnership agreement provides that limited partners cannot be called upon to make additional capital contributions in the future. Samantha Ashin is a plastic surgeon employed by a medical professional corporation. During 2021, she received a salary of $230,000. She also received a total of $19,400 of dividend and interest income from her investment portfolio, and an allocation of $13,200 of operating business income from a partnership in which she has a 3 percent limited partnership interest.

Assignment Requirements



Compute Callaway's taxable income or loss for 2021, and determine the amount of the income or loss that is (1) allocable to and (2) deductible by Samantha Ashin on her 2021 Federal individual income tax return. Present your analysis using a research memorandum format. In preparing this memorandum, support your answers with any sources of authority that apply. Note that this is an individual project.



Callaway Real Estate Limited Partnership

Operating Revenues and Expenses

For January 1–December 31, 2021



Gross rental revenue $2,100,000

Monthly operating expenses

$1,675,000



Repairs and maintenance 212,000

Interest expense 562,000

Property taxes 188,000

Total expenses $2,637,000

Net cash flow from operations* ($537,000)



*Callaway financed the negative cash flow from operations by fully recourse short-term borrowing. The management fee has not been included in expenses.



Compute Callaway's taxable income or loss for 2022, and determine the amount of the income or loss that is (1) allocable to and (2) deductible by Samantha Ashin on her 2022 Federal individual income tax return. How would your answer to (2) change, if Samantha was a general partner instead of a limited partner?

Answer 1

Callaway's taxable loss for 2021 is allocated to Samantha Ashin based on her 38 percent limited partnership interest. The amount she can deduct on her 2021 Federal individual income tax return is limited to her basis in the partnership, which is the value of the land she contributed. If Samantha was a general partner, her deductible amount would depend on her overall tax situation and the limitations imposed by the tax law.

To compute Callaway's taxable income or loss for 2021, we need to subtract the total expenses from the gross rental revenue.

The total expenses include the monthly operating expenses, repairs and maintenance, interest expense, and property taxes.

The net cash flow from operations is also deducted from the gross rental revenue.

This results in a taxable loss for 2021.

However, since this is a partnership, the partnership's income or loss is allocated to the partners based on their specified percentage interests.

In this case, Samantha Ashin has a 38 percent limited partnership interest, so she will be allocated 38 percent of the partnership's taxable loss for 2021.

The deductible amount on Samantha Ashin's 2021 Federal individual income tax return will depend on her other sources of income and the limitations imposed by the tax law.

Generally, an individual can deduct losses from a partnership to the extent of their basis in the partnership and any amounts at risk.

However, the partnership agreement states that limited partners are not subject to the deficit restoration requirement. This means that Samantha Ashin's deductible amount will be limited to her basis in the partnership, which is the value of the land she contributed.

Therefore, she can deduct the allocated loss up to her basis in the partnership.

If Samantha Ashin was a general partner instead of a limited partner, her deductible amount would depend on her overall tax situation and the limitations imposed by the tax law.

General partners have additional responsibilities and liabilities compared to limited partners.

They are generally subject to the self-employment tax on their distributive share of partnership income, which includes both profits and losses.

However, they may also have more flexibility in deducting partnership losses against their other sources of income, subject to certain limitations.