Question

A and B, both dealers in real estate, find a parcel of land to purchase for $100,000 as an investment. They believe it can be sold in 2 years for $200,000. They either will buy the land as tenants-in-common for $100,000 and jointly contribute it to a partnership or contribute $50,000 each to an equal partnership, which then will buy the land.

(a) How should they structure the transaction?

(b) Assume the AB partnership purchased the land for $100,000 in Year One and it appreciated in value to $200,000 by the beginning of Year Three. At that point, C joins the partnership as an equal partner by contributing $100,000 cash to be used by the partnership to improve the land and sell it. The partners believe they can sell the land for $450,000. What result for tax and book purposes if the partnership sells the improved parcel of land for $450,000 and allocates the gain to reflect the appreciation at the time of C’s entry into the partnership?

(c) What results to the partners under the facts of (b), above, if they elect to use a reverse Internal Revenue Code Section 704(c) allocation under Regulation Section 1.704-1(b)(2)(iv)(f)(5) and they apply the traditional method of allocation.

(d) What result on a sale of land for $450,000 if the capital accounts of the partners are not adjusted when C joins the partnership and the agreement does not include any special allocation to reflect the built-in-gain at the time C became a partner?

Answer 1

Answer a)

When A & B start a business, or carry on a trade together to turn a profit, the result can be profit or loss and the parties can decide to go their separate ways. As per the law, by the very nature of entering into business with another party, A&B may be considered a partnership whether they have a written agreement or not. It's best to follow certain legal and practical steps to structure this relationship so that it is a win-win for all concerned.

• Writing a Business Plan
• Choosing a Name
• Understanding A & B Tax Obligations
• Obtain an employer identification number.
• Obtain licenses and permits.
• Choose a location
• Writing the Partnership Agreement
  • some critical elements to include in a partnership agreement
  • Partnership information (Partners & Capital Contribution, Partners Details and etc.)
  • Profit and loss distribution-How to share profit between A&B
  • Rules concerning voting, admitting new partners, and management.
  • The exit strategy-How to sell and close out the business
• In this case it is necessary to debit cash account 100,000 and credit capital account of A & B 50,000 each. This is the primary accounting entries needed.

Answer b)

Partner	A	B	Total
Capital Contribution	50,000.00	50,000.00	100,000.00
Value at the beginning of year 3			200,000.00
Gain apportion among partners before C joins	50,000.00	50,000.00	100,000.00
Capital Account Balance at the beginning of year 3	100,000.00	100,000.00	200,000.00
Partner	A	B	C	Total
Capital Account Balance at the beginning of year 3	100,000.00	100,000.00
Capital Contribution			100,000.00
Total Capital	100,000.00	100,000.00	100,000.00	300,000.00
Estimated selling price				450,000.00
Gain apportion among partners after C joins	50,000.00	50,000.00	50,000.00	150,000.00
Total Gain For Each Partners	100,000.00	100,000.00	50,000.00	250,000.00

Answer d)

Under this method the gain is caclulated based on the capital contribution by each partners
Partner	A	B	C	Total
Estimated selling price				450,000.00
Capital contribution	50,000.00	50,000.00	100,000.00	200,000.00
Allocation based on capital contribution	112,500.00	112,500.00	225,000.00	450,000.00
Gain apportion among partners	62,500.00	62,500.00	125,000.00	250,000.00