Remaining partner's basis after forfeiture?

[BHoffman]

Partner A forfeited his interest in Partnership AB. The partnership agreement states that upon forfeiture, the assets transfer to Partner B.

No hot assets, no liabilities. Nothing except assets and equity.

Assets were:

Land basis $1,000
Securities basis $200
Real estate basis $100

Partner A held 99% before forfeiture. Partner B held 1%. Before the forfeiture, Partner B's total basis in the partnership was $100.

Upon forfeiture, the partnership terminated leaving all of the assets to Partner B.

What is Partner B's basis in the assets?

[Jack from Ohio]

Is this a test to see if we have learned about basis?

[BHoffman]

Nope.  It's a plea for help.  My burned out brain cells have not rejuvenated yet from last tax season and the Phoenix heat isn't helping

[Jack from Ohio]

The remaining partner's basis would be his basis plus the forfeiting partners basis at the time of the transfer.

[Elrod]

 

                                                                                                     100%

[BHoffman]

So, the land becomes the personal property of Partner B with a basis of $1,000?  And if he sells the land for $1,500, he would report a taxable gain of $500? 

Sorry to be so thick and thanks for your patient answers.  Never dealt with a forfeiture before.

[Jack from Ohio]

So, the land becomes the personal property of Partner B with a basis of $1,000?  And if he sells the land for $1,500, he would report a taxable gain of $500? 

Sorry to be so thick and thanks for your patient answers.  Never dealt with a forfeiture before.

As long as Partner A had sufficient inside basis, the answer would be yes.  If there were any transactions that lowered partner A's basis in the partnership, then that number must be used.  Same for Partner B.  If there have been transactions to lower his basis in the partnership, his basis would be lower as well.

[BHoffman]

Thank you Jack.  Can you point me to anything official?  The numbers I've given have a few more zeros at the end so I'm concerned and this is unchartered territory.

 

 

[BHoffman]

I think it's going to be Sec 731 and/or 732.  And I think it's going to be a long and boring day.

[SaraEA]

If A takes a loss on his partnership interest, does that affect the basis in the assets?  I don't have a research materials with me so don't have the answer.  Are the parties related?  Does the transaction have what the IRS calls "economic substance"?  Did A contribute appreciated/depreciated assets to the partnership?  This whole thing sounds like a windfall for B, which may be the intent of A.  (A had appreciated property and stock, stuck it in a partnership, abandoned it, and gets to claim a loss instead of a gain.)

The reason I'm skeptical is that after years of struggling through multiple courses in partnership taxation I realized that the reason why the rules are so unbelievably complex is that people have used partnerships to do all sorts of things to avoid taxable income.  When the IRS catches on and creates a new rule, people find ways around it, which leads to more new rules.  I often felt that the only way to clarify the taxation of partnerships is to throw that whole section of code away and start over.

[BHoffman]

It's a long story.  Back in the 90s, a fancy financial advisor talked these nice people into making a charitable contribution of cash, securities, and land to PtrA, and then a fancy lawyer created a corporation held by the nice people.  The corporation and PtrA formed a partnership that held the charitably contributed assets.  The nice people were unable to take the full charitable deduction as it was large and expired after 5 years.  IRS audited them for this issue and found no change.

Then, PtrA lost his nonprofit status, and that caused him to forfeit his partnership "units" to PtrB per their agreement.  The partnership terminated.  PtrA didn't put anything into the partnership except the charitable contribution from the nice people.  The nice people received a tax benefit for the charitable contribution deduction allowed back in the 90s.  Now that PtrA forfeited, I believe PtrB's basis should include PtrA's basis minus the tax benefit of the original charitable contribution.  I think that is the actual "economic substance" of the thing, but I don't think that's how the law is written.  

To answer your questions:  I don't know if PtrA took a loss or not.  The parties are not related.  PtrA really contributed nothing that B didn't give him.  I'm signed up for some partnership tax courses this summer.  Partnerships are my least favorite and this is a real dinger.

[kcjenkins]

Absolutely correct, and the POSSIBLE reason behind this example is that A is trying to transfer a gift to B but avoid gift tax,  If there is ANY relationship between A and B, for sure that's how the IRS will see it.  Maybe these links will help.  

http://www.irs.gov/Businesses/Partnerships/Partnership---Audit-Technique-Guide---Chapter-7---Dispositions-of-Partnership-Interest-(Rev.-3-2008)

http://www.rutan.com/files/Publication/ac056037-38dc-494e-b9da-23e78c269187/Presentation/PublicationAttachment/158a0e07-f0da-4687-a37a-27b6cde9c966/TaxNotesMartinson.pdf

http://www.alvarezandmarsal.com/ordinary-loss-worthless-partnership-interests-still-alive

[BHoffman]

Thanks - I read the ATG and some other things.  The parties are absolutely not related at all.

 

[kcjenkins]

That's good.  So why is he forfeiting his interest?  Understanding the motive night make the options clearer to me. 

[BHoffman]

According to the partnership agreement, if PtrA loses his nonprofit tax status then he forfeits his partnership units to PtrB.  PtrA lost his nonprofit tax status, or rather the IRS took it away.

[Lion EA]

There may be nonprofit rules that supercede the partnership agreement.  For example, is the nonprofit allowed by federal or state law to forfeit his partnership units to B or must he give them to another nonprofit or even to the state or return them to the donor or...?

[BHoffman]

Hi Lion - another attorney confirmed that the partnership agreement language regarding the forfeiture of units by the nonprofit was OK.

[Lion EA]

That's pretty cool.  Donate to a new nonprofit you set up to receive the donation.  Get a tax deduction on your 1040.  Then the private (not nonprofit) walks away with the donation at no cost to them.  I can see why people retire to Arizona!

[BHoffman]

Hi Lion - the nonprofit was in existence for a long time before the nice people got roped in.  They lost most of their charitable contribution deduction due to the 5 year carryover period.  They got totally screwed.  It's a mess and I'd like to help them out, but Sec 731 and 732 are pretty clear

So, it looks like the nice people own land and real estate assets in an SCorp with zero basis and a huge tax bill when/if they sell.

If they leave the assets in the SCorp until they die, will the inheritors of the SCorp be able to adjust the basis to FMV on date of death?

 

[BHoffman]

....and here is an answer:

http://www.unclefed.com/AuthorsRow/TaxBusProf/deathofshrareholder.html