Question

G and L organize the GL partnership. Each contributes $50 for his partnership interest. The partnership purchases an apartment building for $1,000, making a $100 down payment and paying the remainder of the price with a mortgage loan. The principal of the mortgage loan is payable in a single payment after 12 years. The gross income and deductions of the partnership for each of the first few years are expected to be as follows:Rent: $240Cash operating expenses $150Interest expense 90Depreciation expense 50($290)Loss ($50)The partnership agreement allocates all depreciation to L. All other gross income and deductions are allocated to the partners equally.The partnership agreement provides that all income, gains, losses and deductions will be reflected in the partners’ capital accounts (which will be maintained in accordance with Reg. Sec. 1.704-1(b)(2)(iv)); and each partner will be entitled on liquidation (of either the partnership or the partner’s interest) to distribution of an amount equal to his positive capital account balance.Assume that the partnership operates for two years, and then sells the building at the beginning of year 3 for, alternatively, $1,100 or $800. How will the partnership’s income, gain, loss and deduction (including depreciation deductions) be allocated between G and L, and will the allocations be respected for federal income tax purposes, in the following alternative variations?(a) The partnership is a general partnership, the mortgage lender has full recourse against the partnership and the partners, and any partner having a deficit in his capital account when either the partnership or his interest is liquidated must then make an additional capital contribution equal to that deficit.(b) The partnership is a limited partnership with G as the general partner and L as the limited partner; the mortgage loan is recourse; and the partnership agreement says nothing about capital account deficit restoration on liquidation of a partner’s interest.(c) Same as (b), except L is obligated to restore any deficit in his capital account to the extent that it does not exceed $50, and there is a "QIO" provision [within the meaning of Reg Sec. 1.704-1(b)(2)(ii)(d)] in the partnership agreement.(i) Would the year 2 allocations have economic effect or alternate economic effect if: (1) as of the end of year 2 of operations, the partnership plans in year 3 to borrow $60 on a recourse basis and distribute the cash proceeds of the loan equally to G and L, and (2) the partnership reasonably expects to earn $60 net income in year 3?(ii) What if, in year 3, the partnership borrows $60 and distributes $30 to each of G and L as planned, but unexpectedly earns only $40 (net income)?

Answer 1

In a partnership, the allocation of income, gain, loss, and deduction is determined by the partnership agreement and needs to be respected for federal income tax purposes. The income, gain, loss, and deduction would be allocated differently depending on the partnership type and provisions of the agreement.

Step-by-step explanation:

In a partnership, the income, gain, loss, and deduction are typically allocated between partners based on their partnership agreement. However, the allocations must also be respected for federal income tax purposes. Let's analyze how the income, gain, loss, and deduction would be allocated in the given scenarios:

(a) General Partnership with Full Recourse Mortgage

In this scenario, the income, gain, loss, and deduction would be allocated equally between G and L, as per the partnership agreement. The partnership agreement provision for allocating all depreciation to L would also be respected. The allocations would be respected for federal income tax purposes.

(b) Limited Partnership with Recourse Mortgage

As a limited partner, L would not be involved in the partnership's day-to-day operations. Therefore, the income, gain, loss, and deduction would be allocated to G as the general partner. The partnership agreement does not mention capital account deficit restoration, so there would be no requirement for L to restore any deficit in his capital account. These allocations would also be respected for federal income tax purposes.

(c) Limited Partnership with Recourse Mortgage and QIO Provision

In this scenario, L would be obligated to restore any deficit in his capital account up to $50. The income, gain, loss, and deduction would still be allocated to G as the general partner. The QIO provision in the partnership agreement would ensure that allocations are respected for federal income tax purposes.