Final answer:
The correct tax treatment for the sale of land by the AQR partnership is to allocate the first $40,000 of gain to Acre and then share the remaining $60,000 gain equally among all partners, including Acre, resulting in each partner recognizing a capital gain of $20,000, with Acre recognizing a total gain of $60,000.
Step-by-step explanation:
The tax treatment of the gain from the sale of land contributed by partner Acre to the AQR partnership and subsequently sold to a third party involves identifying the correct allocation of gain among the partners. When Acre contributed land with a fair market value (FMV) of $100,000 and a tax basis of $60,000, Acre had a built-in gain of $40,000 (the difference between the land's FMV and its tax basis) at the time of the contribution. In the event of the sale of land for $160,000, the total realized gain is $100,000, which is the difference between the sale price and Acre's original tax basis in the land.
According to the Internal Revenue Code and U.S. tax principles, the precontribution gain of $40,000 is specifically allocated to Acre, who contributed the asset with the built-in gain. The remaining gain of $60,000 should then be divided equally among the partners, as they share equally in the partnership gains and losses. Each partner would thus recognize a capital gain of $20,000 from this portion of the gain, in addition to Acre's allocated $40,000. Therefore, the second option is the correct tax treatment: the first $40,000 of gain is allocated to Acre, and the remaining gain of $60,000 is shared equally by all the partners in the partnership.