Question

A (a cash method taxpayer) is an equal partner in the ABCD partnership (an accrual method taxpayer) and has a $10,000 outside basis in her partnership interest. A owns depreciable personal property (fair market value -- $15,000; fair rental value -- $1,000 per year) which the partnership will use in its business. Before any of the transactions described below, the partnership has $10,000 of net income each year. What result in the following alternatives?

(a) A leases the property to the partnership for 3 years. The partnership will pay A $1,000 per year for 3 years for the use of the property.

(b) What result in (a), above, if the rental payments are made on January 31 of the year following accrual?

(c) A transfers the property to the partnership, which will use it for 3 years and transfer it back to A at the end of that period. The partnership makes a special allocation of its first $1,000 of net income to A. What result to A? What if, instead, the first $3,000 of the first year’s net income and no subsequent income in excess of her one-quarter share is allocated to A?

Answer 1

1. (a) A leases the property to the partnership for three years. The partnership will pay A $1,000 per year for three years for the use of the property.
   1. A is not acting as a partner. He is renting property to the p’ship.
   2. § 707(a)(1): treat as if the transaction is btwn the p’ship and an outsider. Business expenses to partnership.
   3. When the p’ship pays the $1k rent:
      1. $10k net income – $1k rent ded. = $9k net income to divide among the partners

A	B	C	D
$2.25k	$2.25k	$2.25k	$2.25k
$1k rental income

1. (b) What result in (a), above, if the rental payments are made on January 31 of the year following accrual?
   1. § 267(a)(2), (e): p’ship can’t take the deduction until the partner includes the pmt in GI
   2. $10k net income to allocate among partners

A	B	C	D
$2.25k	$2.25k	$2.25k	$2.25k

1. When p’ship pays $1k rent in year 2:
   1. Partner includes in GI (b/c he’s a cash method taxpayer)
   2. P’ship takes $1k deduction
   3. Same result as in part (a)
2. (c) A transfers the property to the partnership, which will use it for three years and transfer it back to A at the end of that period. The partnership makes a special allocation of its first $1,000 of net income to A. What result to A?
   1. What’s the entrepreneurial risk to A?
      1. If the pmt is pretty certain, tends to look like a disguised pmt under §§ 707(a)(2)(A); 707(a)(1). Payment is pretty certain so likely a disguised payment. Benefit to PR only, not the PNS. No deduction to the PNS.
      2. If there is entrepreneurial risk, treat it as pmt to a partner acting as a partner w/ reference to p’ship income (1st category above)
   2. § 707(a)(2)(A): disguised paymentàtreat as a transaction in § 707(a)(1)
      1. Same result as in parts (a) and (b), disguised payment
      2. If p’ship makes pmt this year:
         1. P’ship takes $1k deduction
         2. A has $1k GI
         3. Remaining is allocated among partners
      3. If defers pmt, defers deduction
   3. If there is a level of entrepreneurial risk; treat A as a partner
      1. First $1k is allocated to A. The remaining is allocated equally among A, B, C, and D

A	B	C	D
$2.25k	$2.25k	$2.25k	$2.25k
$1k allocation

1. Character is determined at p’ship level
2. Timing is governed by § 706(a)
3. A’s basis is increased by $3,250, then decreased by $1k when p’ship makes the pmt to A