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Tax Consequences of Issues

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In each of the following problems, identify the tax issue(s) posed by the facts presented. Determine the possible tax consequences of each issue that you identify.

57. Lydia owns 75% of Flower Farms, a partnership. She also owns land that she leases to Flower Farms for $6,000 per month.

58. Micheal buys a piece of property from JFK Partnership for $60,000 that has a $70,000 basis. Micheal owns 80% of JFK Partnership.

59. Irene contributes land to Micro Development Partnership for a 30% interest. The land's basis is $20,000, and it has a fair market value of $80,000. Micro reports a net operating loss of $100,000 for the year. Irene devotes at least 12 hours a week to managing the partnership operations.

60. Powell owns a 20% interest in Cooke Partnership. At the beginning of 2008, Powell's basis is $22,000. Cooke reports a $90,000 operating loss in 2008, and Powell withdraws $10,000 from the partnership. Cooke's 2009 operating income is $70,000, and Powell withdraws $10,000 from the partnership.

61. Ramrod, Inc., sells a warehouse for $350,000. It purchased the warehouse 10 years ago for $250,000 and had taken $75,000 in depreciation on the building to the date of the sale.

62. Myrtle Coast Corporation has a $35,000 operating loss during the current year. Not included in the loss is a $40,000 dividend it received from a corporation in which it owns a 15% interest.

63. LMC, Inc., is equally owned by Larry, Maurice, and Charles. The owners are sports agents. LMC's income consists solely offees from the owners' clients. During the current year, LMC's net income from operations is $380,000, and it receives $20,000 in interest income. The corporation owns an interest in a limited partnership that generates a $24,000 loss in the current year.

64. Assume the same facts as in problem #63, except that LMC, Inc is an electing S corporation.

65. Kummell Corporation reports a $200,000 taxable income in the current year. Included in the taxable income calculation are $20,000 in dividends received from less-than-20% owned corporations, and $30,000 in charitable contributions.

66. Milena owns a 25% interest in Davis Company, an S corporation. Her basis in the Davis stock os $40,000. Davis reports an operating loss of $200,000 in the current year. Davis owes Milena $25,000 on a loan she made to the company several years ago.

67. Charlene owns a 70% interest in Maupin Mopeds, which is organized as a partnership. She wants to open another business and needs office space for it. She has Maupin distribute a building worth $150,000 to her in lieu of her normal cash distribution. Maupin's basis in the building is $55,000. Charlene's basis in Maupin is $80,000.

68. Ballou Corporation distributes $200,000 in cash to its shareholders during the current year. Accumulated earnings and profits at the beginning of the year are $45,000, and current year earnings and profits are $105,000. Buddy owns 80% of Ballou and has a basis of $60,000 at the beginning of the year.

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The solution assists in answering the tax consequences of issues in the 12 problems given.

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57. Lydia owns 75% of Flower Farms, a partnership. She also owns land that she leases to Flower Farms for $6,000 per month.

Our issue is whether the partnership can transact with a partner. Partners can transact at arm's-length with a partnership as long as they are not related parties. The partner and partnership are related parties if the partner directly or indirectly owns more than 50 percent of the partnership. A related party partner can also transact at arm's-length with the partnership in loan and rental transactions. Besides payments for services to a partner are also considered arm's length if the partner is not acting as a partner in providing the services. So Flower Farm can deduct the $6,000 monthly rental payment it makes to Lydia.
Here the deduction is subject to the reasonableness requirement. Flower Farm can only deduct the amount of the rental payment to Lydia that is reasonable in amount. Therefore, if comparable land rented for only $2,000 per month. Flower Farm could only deduct $2,000, the reasonable rental for the land.

58. Michael buys a piece of property from JFK Partnership for $60,000 that has a $70,000 basis. Michael owns 80% of JFK partnership.

The problem is whether the partnership can sell the property to Michael and deduct the loss. The related party rules apply to sales between a partnership and a partner, if the partner owns more than a 50% interest in the partnership. Thus the partnership will not be able to deduct the $10,000 loss and Michael will have a $60,000 basis in the property. If Michael subsequently sells the property for more than $60,000, he can offset the amount of his gain up to the partnership's disallowed loss of $10,000.

59. Irene contributes land to Micro Development Partnership for a 30% interest. The land's basis is $20,000, and it has a fair market value of $80,000. Micro reports a net operating loss of $100,000 for the year. Irene devotes at least 12 hours a week to managing the partnership operations.

Here the problem is if Irene can deduct her pro rata share of the loss or not. There are three sets of rules govern limitations on the amount of the loss deduction. These are the basis rules, the at-risk rules, and the passive activity loss rules. The third one (passive activity rules) are only applicable if Irene does not materially participate in the activity. Based on the information it is difficult to determine whether Irene would be treated as a material participant.
If she is considered a material participant, she will be allowed to deduct her ratable share of the partnership loss to the extent of her basis ($20,000) in the partnership. This is also the amount that she is at-risk. The remaining $10,000 loss is not deductible until her basis in the partnership is increased. If she is not a material participant, then she cannot deduct any of the loss. The loss is treated as a suspended passive loss and is deductible only when Irene has other passive income to offset loss or when she disposes of the passive activity.

60. Powell owns a 20% interest in Cooke Partnership. At the beginning of 2009, Powell's basis is $22,000. Cooke reports a $90,000 operating loss in 2009, and Powell withdraws $10,000 from the partnership. Cooke's 2010 operating income is $70,000, and Powell withdraws $10,000 from the partnership.

Here the problem is whether Powell can deduct his pro rata share of the loss. Three sets of rules govern limitations on the amount of the loss deduction: the basis rules, the at-risk rules, and the passive activity loss rules. The passive activity rules are ...

Solution provided by:
Umut Oltulu, MBA
Education
  • BSc, Dokuz Eylul University
  • MBA, Texas A&M University-Kingsville
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