Question

The Callaway Real Estate Limited Partnership (Callaway) was formed on January 1, 2022, 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, 2022,
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 2022. A summary of partnership operating revenues and expenses for
2022 is attached. In addition to operating revenues and expenses, the partnership also
calculated depreciation on the apartment complex for 2022 in the amount of $127,273
($4,000,000 depreciable basis / 27.5 = $145,455 annual depreciation X 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 Reg. Sec. 1.704-1(b)(2)(ii)(d).
On January 20, 2022, 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
2022, 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.
Callaway Real Estate Limited Partnership
Operating Revenues and Expenses
For January 1–December 31, 2022
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.Specifically, the corporate general partner, Tambour Properties Inc., is receiving payments in return for management services it is providing to the partnership. In addition, we are going to advise one of the limited partners, Dr. Samantha Ashin, on how the partnership’s operations will impact her basis and tax return during the year. They will want to know the partnership’s taxable income or loss for 2022, and 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. Also, include what would change if Samantha was a general partner instead of a limited partner. How is the management fee loss treated and and how much of that loss will be included in the current year?

Answer 1

Dr. Samantha Ashin, a limited partner in Callaway Real Estate Limited Partnership, will report her share of allocated income and depreciation on her tax return, including the deductible management fee loss.

Let's analyze the key aspects of Callaway Real Estate Limited Partnership's operations and how they impact Dr. Samantha Ashin, a limited partner:

1. Operating Revenues and Expenses:

- 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)

The negative cash flow was financed by short-term borrowing. The management fee is not included in the expenses provided.

2. Depreciation:

- Depreciation on the apartment complex for 2022: $127,273

3. Capital Contributions and Capital Accounts:

- Dr. Samantha Ashin contributed undeveloped land with an appraised value of $275,000 in exchange for a 38 percent limited partnership interest.

- The partnership agreement states that limited partners cannot be called upon for additional capital contributions.

4. Taxable Income Allocation:

- All partnership taxable income, gain, or loss is allocated 5 percent to Tambour (the general partner) and 95 percent to the limited partners. Samantha receives 40 percent of the 95 percent allocation.

5. Samantha's Other Income:

- Salary: $230,000

- Dividend and interest income: $19,400

- Operating business income from another partnership: $13,200

6. Tax Impact on Samantha Ashin:

- Samantha's taxable income from the partnership includes her share of the allocated taxable income, depreciation, and any other income passed through by the partnership.

- She will report her share of partnership income on her individual tax return.

7. Treatment of Management Fee Loss:

- The management fee paid to Tambour Properties Inc. is a deductible expense for the partnership.

- Samantha's share of the management fee loss will be part of her allocated partnership loss, reducing her taxable income.

8. Limited vs. General Partner Impact:

- Limited partners, including Samantha, are not subject to deficit restoration requirements.

- If Samantha were a general partner, she would be personally responsible for deficit restoration in her capital account.

It's important for Samantha to consider her overall tax situation, including the partnership income, when preparing her individual tax return. Consulting with a tax professional is recommended for specific advice tailored to her circumstances.