Question

LO.3 - Determine the tax effects of forming a partnership with cash and property contributions., 9 - Determine a partner’s basis in the partnership interest., 17 - Identify tax planning opportunities related to partnerships and their partners. Sam and Drew are equal partners in SD LLC formed on June 1 of the current year. Sam contributed land that he inherited from his uncle in 2012. Sam’s uncle purchased the land in 1985 for $30,000. The land was worth $100,000 when Sam’s uncle died. The fair market value of the land was $200,000 at the date it was contributed to the LLC.

Drew has significant experience developing real estate. After the LLC is formed, he will prepare a plan for developing the property and secure zoning approvals for the LLC. Drew would normally bill a third party $50,000 for these efforts. Drew also will contribute $150,000 of cash in exchange for his 50% interest in the LLC. The value of his 50% interest is $200,000.

1. How much gain or income will Sam recognize on his contribution of the land to the LLC? What is the character of any gain or income recognized?

2. What basis will Sam take in his LLC interest?

3. How much gain or income will Drew recognize on the formation of the LLC? What is the character of any gain or income recognized? Does Drew have a “carried interest”?

4. What basis will Drew take in his LLC interest?

Answer 1

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a )How much gain or income will Sam recognize on his contribution of the land to theLLC?What is the character of any gain or income recognized?

Answer:

None.

As per § 721, neither LLC nor any of the members can recognize the gain on the contribution for the property to the LLC in exchange of interest in LLC.

b. )What basis will Sam take in his LLC interest?

Answer:

Sam should take the $100000 adjusted basis.

Basis of Sam in his LLC interest will equal to basis he held in property which he inherited from his uncle. Basis that beneficiary can take in the property received from the estate are equal to fair market value of an asset at date on death or at alternate date of valuation .Sam's basis in the property will be inherited from his uncle so fair value on the date of death, and Uncle's estate will be taxed for the 70,000 gain ( $100,000-$30,000). Therefore,

c.How much gain or income will Drew recognize on the formation of the LLC? What is the character of any gain or income recognized?

Drew can recognize $50,000 of an ordinary income.

Fair market value of Drew’s 50% LLC interest is $200,000. Because Drew could contribute only $150,000 for property, difference between amount contributed & the value for interest will be treated as services rendered to LLC.

Here Services do not constitute as ‘‘property’’ for the purposes of § 721 non recognition of treatment.

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d) What basis will Drew take in his LLC interest?

Answer:

Basis of Drew in his LLC interest is $200,000

=[$150,000 (the cash contributed) add: + $50,000 ( amount of ordinary income which recognized for the services rendered to partnership)]