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)
Give the client advice . 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. Be sure to include the relevant authority as well as the tax implications for this partnership.
How do we treat the management fee loss and what is the authority? What are the limits for this case and what can they only deduct ? How much of the loss can she use and allocated? Is she acting as a partner or non partner?
How much is distributed to Samantha of depreciation ?

Answer 1

The Callaway Real Estate Limited Partnership had a net loss of $664,273 in 2022. Samantha Ashin, with a 38% interest, can allocate a loss of $239,974.35, limited by her basis in the partnership. As a limited partner, her deductible loss is further constrained versus being a general partner, where she'd have unrestricted deduction but increased liability.

Calculating the taxable income or loss for the Callaway Real Estate Limited Partnership for the year 2022 involves subtracting total expenses from the gross rental revenue. First, we ascertain the partnership's net income before the depreciation expense since the gross rental revenue is $2,100,000 and the expenses total up to $2,637,000. This results in a net loss of $537,000. Next, we consider the depreciation expense (which for the accounting period is calculated to be $127,273), leading to an adjusted net loss of $664,273 ($537,000 + $127,273).

Samantha Ashin, holding a 38% limited partnership interest, will be allocated 95% of this loss which amounts to ($664,273 * 95% * 38%) = $239,974.35. As a limited partner, under the Internal Revenue Code and Treasury Regulations, her ability to deduct these losses is typically limited to her basis in the partnership, which includes her capital contribution and her share of the partnership liabilities. Since limited partners cannot be called upon to make additional contributions in the Callaway partnership agreement, her risk of loss is limited and any excess losses over her basis cannot be currently deducted but instead are carried forward.

Since the management fee paid to Tambour is a reasonable and ordinary expense that is necessary for the production of income, it is deductible for the partnership under IRC Section 162. Samantha, as a limited partner, is not involved in the day-to-day operations and is not liable for the debts of the partnership beyond her capital contribution. As a general partner, the tax situation would differ since she would actively participate in the management and be personally liable for the partnership debts, which could affect her ability to deduct losses.

In terms of depreciation allocated to Samantha, since she has a 38% limited partnership interest, of the $127,273 depreciation calculated for the year, her allocation would be $127,273 * 38% = $48,363.74 (before applying the 95% distribution percentage).