Category: Individuals; Partnerships & LLCs; Tax
Returns, Examinations & IRS Procedure Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Facts At the end of 1993, the partnership return showed the following tax basis figures. Cash $36,382 The property is titled in the joint names of the individuals. The partnership has a bank account in its own name. The lease on the building runs between the co-tenants and the lessee. The debt appears to be in the name of the partnership. Issues 2. Is there a potential gain on the conversion to joint tenant filing status ? 3. What is the effect on depreciation lives and methods? Answers/Discussions Issue 1 Regulation Section 1.761-2 allows co-owners of property to elect out
of the partnership provisions of Subchapter K in the following circumstances. (i) Own the property as co-owners, (iii) Do not actively conduct business or irrevocably authorize some person or persons acting in a representative capacity to purchase, sell, or exchange such investment property, although each separate participant may delegate authority to purchase, sell, or exchange his share of any such investment property for the time being for his account, but not for a period of more than a year, then... such group may be excluded from the application of the provisions of subchapter K under the rules set forth in paragraph (b) of this section. The issue is whether or not the partnership in this case meets the above requirements. Of particular concern is the lack of an active business; however, in most cases a pure net lease is not viewed as conduct of an active business. Although the IRS could argue to the contrary, it would appear that the co-ownership in question does not involve the conduct of an active business. The courts have also looked to the intent of the parties to be treated as a partnership focusing on how the co-owners represented themselves to outsiders. For example, did the co-owners do business in the name of the partnership? Did the co-owners have a bank account in the name of the partnership? Was a partnership tax return filed? See for example, Mihran Demirjian, 54 TC 1691 (1970), aff'd, 47 F2d 1 (3d Cir. 1972); George Rothenberg, 48 TC 369 (1967); Roy P. Varner, 32 TCM 97 (1973); cf. Estate of Levine, 72 TC 780 (1979), aff'd on another issue, 634 F2d 12 (2d Cir. 1980); and Bentex Oil Corp., 20 TC 565 (1953). In this case, the taxpayers have presented a mixed message to the outside world. On the one hand, the lease and the property title are consistent with co-tenancy. On the other hand, the partnership has a bank account in its own name, possibly debt in its own name, and most importantly has filed partnership income tax returns. These inconsistencies could very much work against the taxpayer's desired position in this case. It is impossible, given the murky state of existing precedent in this area, to predict with certainty how this issue would be decided if it were scrutinized. In my personal view, the taxpayer's chances of success are not greater than 50%, and perhaps less. If the taxpayer wishes to elect out, a partnership return is filed under the normal deadlines. Instead of the information normally included on the return, the taxpayer simply provides all the following information.
Issue 2 The law does not specifically address whether electing out of an existing partnership constitutes a tax liquidation of the partnership or simply a change in the means of filing returns. Generally, taxpayers elect out from the outset of an investment rather than in mid-stream. Suppose that electing out constitutes a liquidation. Section 731(a) says no gain or loss is recognized by a partner as a result of a liquidating distribution except to the extent that cash received exceeds the basis of the partner's interest immediately prior to the distribution. Since both partners have basis in excess of their share of partnership cash, no gain would be recognized by the partners on liquidation. Section 731(b) provides that a partnership will not recognized gain as a result of distributing property including money to a partner. Accordingly, the partnership would not recognize gain if electing out were deemed to be a liquidation. Section 732 provides that the basis of property (other than money) distributed by a partnership to a partner in liquidation of the partner's interest shall be an amount equal to the adjusted basis of such partner's interest in the partnership reduced by any money distributed in the same transaction. Under this provision, the basis of the land and buildings in the hands of the partners would be the same as the basis of the land and buildings inside the partnership. Issue 3 |
