Question

The MN Partnership was formed by Morgan and Nate. Morgan contributed $45,000 cash for a 50% partnership interest. Nate contributed property with a tax basis of $23,000 and a value of $45,000 for a 50% interest.

1. Assume the MN Partnership holds the property contributed by Nate for two years before its sale. (Assume straight-line depreciation and five years left on the recovery period.) How much annual depreciation will each partner have per the books and per the tax allocation assuming the partnership uses the traditional method?

2. Redo part 1 assuming the partnership is using the remedial method. What would the depreciation allocation be in Year 1? (Assume straight-line depreciation and with five years remaining on the asset. A new asset would have a 10 year useful life.)   What would the depreciation allocation be in Year 6?

Answer 1

Solution 01.

At the time of Nate’s contribution, the equipment had a built-in gain of $22000 ($45000 FMV - $23000 tax basis). Partnership uses the traditional method for all of its Sec. 704(c) property. The equipment is depreciated straight-line over 7 years with 5 years remaining.

Partnership would receive Sec. 704(b) book and tax depreciation of $9000($45000 ÷ 5) and $4600 ($23000 ÷ 5), respectively. Generally, for the traditional method, there are five key steps to correctly allocate Sec. 704(b) book and tax depreciation:

1. Compute tax depreciation.
2. Compute Sec. 704(b) book depreciation.
3. Allocate Sec. 704(b) book depreciation.
4. Allocate tax depreciation to the noncontributing partners up to the amount of their allocation of Sec. 704(b) book depreciation. If any tax depreciation remains to be allocated, move on to step 5.
5. Allocate remaining tax depreciation to the contributing partner.

Depreciation allocation
	Nate		Morgan		Partnership
	704(b)	Tax	704(b)	Tax	704(b)	Tax
Capital A/c ,Opening	45000	23000	45000	45000	90000	68000
Step 3: Allocate book depreciation according to Sec. 704(b)	(4500) (9000/2)		(4500) (4500/2)		(9000)
Step 4: Allocate tax depreciation to non contributing partners				(4500)		(4500)
Step 5: Allocate tax depreciation to contributing partners		(100)				(100)
Capital A/c Closing	40500	22900	40500	40500	81000	63400

Step 5= 4500- 4400 (built-in gain of $22000/5) = 100

Solution 02.

Depreciation allocation
	Nate		Morgan		Partnership
	704(b)	Tax	704(b)	Tax	704(b)	Tax
Capital A/c ,Opening	45000	22000	45000	45000	90000	67000
Depreciation of tax basis (22000/5)	(2200)		(2200)	(2200)	(4400)	(2200)
Depreciation of built-in gain (23000/10)	(1150)		(1150)	(100)	(2300)	(100)
Remedial allocation		1050		(1050)
Capital A/c Closing	41650	23050	41650	41650	83300	64700