Question

Five years ago, Farley Walton purchased a 30% interest in Oak Motte Partners, a real estate development partnership. He paid $50,000 for a 30% interest in capital, profits and losses. This year, at the end of the year, Farley sold his interest in the partnership for $250,000 cash to an unrelated buyer. The following table summarizes Farley’s distributive share of partnership profits and losses, as well as distributions received and additional capital contributions made by Farley over the five year period:

Year	Profit/(loss)	Additional Capital Contributions	Distributions Received
1	($18,000)	$50,000*	0
2	(15,000)	7,500	0
3	25,000	0	0
4	37,000	0	45,000
5	58,000	0	25,000

* The Year 1 capital contribution represents Farley’s initial contribution to acquire his interest in the partnership.

Assume that Farley has not retained sufficient records to support the information summarized in the above table. He has not retained copies of Schedules K-1 received from the partnership over the years, and has been haphazard at best in keeping records of payments made to or received from the partnership. Farley’s tax preparer, however, has a copy of the Schedule K-1 received this year.

1. What will be the balance in Farley’s capital account at the end of Year 5, as reported on Schedule K-1 received for that year? (Assume the capital account has been properly maintained over the entire period).

b. What is Farley’s tax basis in his partnership interest at the end of Year 5?

c. How much gain will he report in connection with sale of that interest?

Assume the same above, that Oak Motte Partners has liabilities outstanding of $500,000. All other information is the same.

d.What is Farley’s tax basis in his Oak Motte interest at the end of year 5?

e. How much gain will he report in connection with sale of that interest?

Answer 1

Part A

Farley’s contributions to capital (50000+7500)	57500
Add: Farley’s share of partnership income/(loss) (-18000-15000+25000+37000+58000)	87000
Less: amount of distributions received	(70000)
Balance in Farley’s capital account	$74500

The net amount invested by Farley, directly and indirectly, in the partnership over the five-year period is $74500

Part B

Farley’s contributions to capital (50000+7500)	57500
Add: Farley’s share of partnership income/(loss) (-18000-15000+25000+37000+58000)	87000
Less: amount of distributions received	(70000)
Farley’s tax basis in his partnership interest	$74500

Farley’s tax basis in his partnership interest = Balance in Farley’s capital account

Part C

Taxable gain recognized by Farley = $250000-$74500 = $175500

Part D

Farley’s tax basis in the partnership interest = net investments in the partnership, + 30% share of the partnership in outstanding debts = 74500 + (30%*500000) = $224500

Part E

Taxable gain recognized by Farley = cash payment received+ Farley’s share of partnership liabilities- tax basis = 250000+150000-224500 = $175500