I told Frank that I, Bob Demmett, would write the blog this week to publicly thank him for giving me one of the most complicated partnership tax returns, ever. As Frank mentioned in last week’s blog, this client had everything: contribution of appreciated property, foreign partners, Section 754 elections, unrelated business taxable income, special allocations, etc.
The return is evidence of how complicated the Internal Revenue Code has become and why it will be very difficult to “simplify” it, as the politicians like to say.
This client took in a new partner in 2012. However, the partner did not contribute cash but contributed appreciated real estate with a mortgage. Under the general partnership tax provisions, a contribution of appreciated property to a partnership is not a taxable transaction. The basis of the property to the partnership is the same as the basis in the hands of the contributing partner. In addition, the contributing partner’s basis in the partnership interest is the same as the basis in the real estate. Thus, there is no current recognition of gain and all parties receive carryover basis in order to defer the gain until the real estate is ultimately sold.
So far, no problem; Frank thought he threw me a curve ball but it was nothing I could not handle. As I continued to review, I noticed that the partnership borrowed an additional $1 million and distributed this cash to the contributing partner. Now, all bets are off. Frank just threw me a cutter and it had me spinning.
Why? Because there is an Internal Revenue Code Section and regulations thereunder that discuss “disguised sales” to a partnership. In other words, gain cannot be deferred if the contributing partner receives money from the partnership because now the transaction doesn’t smell like a contribution to a partnership, but, smells like a sale of an asset. In fact, the regulations state that when a contributing partner receives money from the partnership within 2 years of the contribution of property, it is PRESUMED to be a sale.
Now, the project went from a couple of hours to a few days. I had to discuss this with the client, the client’s attorney, the contributing partner, the contributing partner’s attorney and on and on. Finally, I got everyone to agree that, yes; some portion of the gain had to be recognized.
What are the lessons learned?
- The client should have kept us in the loop before the transaction was consummated.
- By closing as many “loopholes” as possible, the Internal Revenue Code has become full of traps.
- Simplifying the Code may allow for these loopholes to come back into play and then Congress will have to close the loopholes and, before you know it, we are back where we started.
- When Frank asks for your help and claims it will take an hour or two, run as far away as possible.
Thanks Frank, can’t wait to work on another project with you!