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Establishing a partner's initial outside basis.

Facts

Patti and Maxine were the original partners of The Andrews Co., a general partnership. Patti contributed $5,000 cash to the partnership. Maxine contributed property with a value of $5,000 and a basis of $3,000. In September 1991, in exchange for services, Laverne was admitted as a partner with a one-third interest in capital and profits. Laverne's interest was valued by the partners at $6,000. She reported that amount as ordinary income (compensation for servicesj, and The Andrews Co. claimed a deduction for the expense. This deduction was specially allocated to Patti and Maxine. On Jan. 5, 1992, Patti sold her interest in The Andrews Co. to Madonna for $8,500. However, Madonna died on July 15, 1992, and her partnership interest passed into her estate. The value of her interest was reported as $9,000 on her estate tax return. At no time did The Andrews Co. have any liabilities.

The partners of The Andrews Co. are considering selling their interests and have asked their tax adviser to help them determine their bases in their partnership interests.

Issue

What were the initial bases of Patti, Maxine, Laverne and Madonna's estate in the interests they acquired in The Andrews Co,?

Analysis

As a first step, a tax adviser must determine each partner's outside basis. A partner who obtains an interest in a partnership in exchange for a contribution of money or property acquires an initial outside basis equal to the amount of cash contributed plus the adjusted basis in the contributed property.

If a partner acquires an interest in exchange for a contribution of services and recognizes taxable income, the partner's initial outside basis is the amount of such income. The partner acquires the same basis that would have been acquired if the partner had received cash or property from the partnership and immediately contributed it to the partnership. When a partner acquires an interest in a partnership other than by contribution (for example, by transfer), the partner's initial outside basis is determined under the rules generally applicable in determining the basis of property. For example, the basis of property acquired by purchase is its cost. Property acquired by gift generally retains the donor's basis, while the basis of inherited property is generally equal to its fair market value (FMV) at the decedent's date of death (or an alternate valuation date, if applicable).

Conclusion

Based on these rules, Patti's initial outside basis was $5,000, the amount of her cash contribution. Maxine's initial basis was $3,000, which was her basis in the contributed property at the time of the contribution. Laverne's initial basis in the interest she acquired for services was $6,000, the amount of taxable income she recognized as for those services. Madonna's initial basis in the partnership interest purchased from Patti was her cost, $8,500. However, on Madonna's death, her estate acquired her interest at a basis equal to its estate tax value (FMV on the date of death), which was $9,000.

Of course, the initial basis of each of the partners is exactly that--the starting point for direct calculation of basis. Each partner's basis is then adjusted annually for income, loss, contributions, distributions, and other items occurring during that year. There is insufficient information to determine each partner's final basis. If their tax adviser had all the K-Is received by each partner, he might be able to calculate the partner's basis by tracing the profits and losses allocated to each partner over the years, assuming there had been no other activity in the partnership that affected basis. (Note: A tax adviser should not rely on the "capital account reconciliation" information on the taxpayers' K-Is.) Worth, Tex., 1992.

Editor's note: This case study has been adapted from PPC Tax Planning Guide-- Partnerships, 6th edition, by Grover A. Cleveland, William D. Klein, Richard D. Thorsen and Philip H. Welch, published by Practitioners Publishing Company, Fort
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Article Details
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Author:Ellentuck, Albert B.
Publication:The Tax Adviser
Date:Jan 1, 1993
Words:654
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