Section 754 election and 743(b) basis adjustment

I finally received appraisals for an asset of a partnership that passed to an estate to evaluate the 754 election. Seemingly simple - they hold land, debt, and then you have capital accounts. Now that I have the appraisal I see the partnership debt exceeds the fair market value of the asset. The basis of the asset is less than the fair market value (negative capital). Therefore, do I still make the election because of the difference between the basis and FMV of the asset?

Do I report anything on the capital account of the K-1 for the transferee or leave it blank if I am not booking anything (reading prior threads it looks like the 743(b) adjustment is not reflected in tax basis capital accounts). Then add the 743(b) adjustment to the transferee basis worksheet?

This is confusing and in the eleventh hour.

Thank you

Here are more detailed figures:

Cash 1,190
Land Basis 199,936
Debt 216,552
Capital -15,426

FMV land $207,000

1. Amount of cash transferee partner would receive upon liquidation - they would have to pay their negative capital balance share of 4,478 to satisfy the debt so zero cash.
2. Amount of tax loss that would be allocated - $0
3. Amount of tax gain - $1,766 (25% - capital accounts aren't equal)

Are negative amounts in 1 treated as a 0 for this calculation and the Section 743(b) basis adjustment is $1,766? If not, how do I account for the $4,478?

Thank you

If those are actual numbers, there is no requirement to make the adjustment (a negative adjustment of greater than $250,000 is required without a 754 election).
The difference is an inside-outside basis difference for the new partner. That is, tax basis of the partner will be different than his/her tax capital account (plus allocated debt).

Hi CaptCook, thank you. I am totally thrown off by the debt being greater than all assets' FMV. Could there not be an upward adjustment for the fact that the land basis is less than the FMV? No matter how much I run these calculations, I come up with zero or negative 243(b) adjustment even though taxable gain on sale of the land (which is currently listed for sale) would be allocated to the estate on full liquidation.

If your client owns 25%, this is going to be more of a hassle than the step-up is worth?

§743(b) only deals with the sale of partnership interests when a §754 election has been made. I doubt the sale of the property will be in the form of selling partnership interests.

I guess there are two possible outcomes, but this reply is in reference to the possible future sale of the property.

25%

Yes- I am disregarding it. I wanted to get a hang onto the concept before tackling the next partnership they own which has property plus securities. From looking at the other appraisal we just got.... yep a downward adjustment will be required because the appraisal is wayyyy more than $250k under basis. Argh.

Make a single column Balance Sheet with 100% of the basis. In the Equity section, break out the capital accounts between the 25% guy and everyone else (75%).

I get negative $3,857 for the 25% guy’s tax basis capital account.

Then run a column for 100% of FMV. On an FMV basis, the 25% guy’s capital account would be negative $2,091.

Now run a column for 25% of the basis. Here, the only capital account that will show up is the 25% guy, at negative $3,857.

Then run a column for 25% of FMV. Here, the only capital account that will show up is the 25% guy, at negative $2,091.

Now we have some symmetry. It’s clear that the difference between negative $3,857 and negative $2,091 is $1,766. (This is also the difference between the 25% guy’s inside share of the land and the corresponding value of his share of the land).

That would be your 743 adjustment. If you want to prove it out, which you’re trying to do, we’d first compute PTC (Previously Taxed Capital) and add to that amount the 25% guy’s share of the debt.

So, PTC would be (1) negative $2,091 cash rec’d at liquidation (2) minus $1,766 tax gain that would arise. Stop there. These add up to negative $3,857, which is exactly equal to the guy’s pre-death tax basis capital account (hence the phrase, “previously taxed capital”). Next, add $54,138 for his share of the debt, assuming he shares in 25% of the debt. PTC plus debt equals $50,281. This is the 25% guy’s share of the inside basis [25% of the cash = $298…and 25% of the land basis equals $49,983, rounded…the sum total is $50,281]. And note that the $50,281 is the guy’s outside basis right before he died.

Next we look to “cash paid” for the interest. In this case, we look to FMV of the interest, which is the negative $2,091. Add the debt share to that of $54,138. Total is $52,047. And note that this is the stepped-up outside basis of the inheritor.

$52,047 exceeds $50,281 (share of inside basis) by $1,766. This is the exact amount that pre-death ending outside basis is less than post-death beginning outside basis. The Sec 754 election allows this disparity to be cured…if you so choose.

I'm confused by this thread. How did an asset of a partnership pass to an estate? Did the partnership die?

Or did you mean to say "an asset held within a partnership whose 25% partner died, causing that partner's interest to pass to an estate"?

If a partnership interest is what passed to an estate, shouldn't we be talking about the fair market value of the partnership interest as a whole?

Jeff- Ohio - thank you for the breakdown. I too was coming up with $1,766 but couldn't get there with the calculations like you just broke down. Very helpful.

Chary - correct me if I am wrong, because this is my first rodeo... The "asset held within a partnership whose 25% partner died causing the interest to pass to an estate" is correct. My understanding was that you have to do the 743(b)adjustments per asset if an interest passes due to death and the difference is greater than $250k, calculated on an asset by asset basis. Am I totally off here? I am facing this with the deceased fellow's other partnership. There is no appraisal of the partnership and there won't be one before the deadline. These are closely held, there is no marketable value or goodwill or receivables or customers...all value is tied up in the asset held within the partnership.

Or did you mean to say "an asset held within a partnership whose 25% partner died, causing that partner's interest to pass to an estate"?

I think that’s what he meant to say.

If a partnership interest is what passed to an estate, shouldn't we be talking about the fair market value of the partnership interest as a whole?

Yes. And we start by taking the two partnership assets and adding them together and then subtracting off the debt. Cash of $1,190 plus Land of $207,000 minus debt of $216,552 gives us negative total equity of $8,362…and 25% of that is the $2,091 (vs. decedent’s tax basis capital account of negative $3,857 at death equals a difference of $1,766). I’m assuming here the debt in question is recourse. If it was nonrecourse, I think the entire negative tax basis capital account of the decedent would be subject to elimination by way of a 743 adjustment.

Jeff-Ohio - I don't see how it could be treated as recourse. It's a loan from another partner with no loan docs. I could go off on a tangent here but I won't digress. It's an LLC at the state level.

My understanding was that you have to do the 743(b)adjustments per asset if an interest passes due to death and the difference is greater than $250k, calculated on an asset by asset basis. Am I totally off here?

I don't think so, but one thing I'm not clear on myself is whether the new rule aggregates all losses when determining whether a partner is "allocated a loss" of more than $250,000, or whether each item of loss counts separately. Separate treatment does seem appropriate, but it's still a little vague for me.

There is no appraisal of the partnership and there won't be one before the deadline. These are closely held, there is no marketable value or goodwill or receivables or customers...all value is tied up in the asset held within the partnership.

So the fair market value is equal to the FMV of the individual assets. Got it, that was the part I was missing. Maybe the other posters already came to this conclusion, but I wasn't able to based only on the facts provided.

If it was nonrecourse, I think the entire negative tax basis capital account of the decedent would be subject to elimination by way of a 743 adjustment.

I'm not following you here. Could you elaborate?

It's a loan from another partner with no loan docs.

Sounds a lot like a contribution to capital.

That aside, even if it is a loan it would be considered recourse debt allocated 100% to the partner that made the loan.

Jeff-Ohio - I don't see how it could be treated as recourse. It's a loan from another partner with no loan docs.

Well then, your guy’s capital account really should be $0, since losses should never have been allocated to him in the first place.

That aside, even if it is a loan it would be considered recourse debt allocated 100% to the partner that made the loan

Chay - that was how I was reporting it on the K-1 for the one who loaned the $. But for purpose of the 743(b) adjustment and the calculation therein, I still take the full debt against the FMV of the assets, yes?

I'm not following you here. Could you elaborate?

It has long been said that the only way to get out of an upside down capital situation is to die. If you are alive, and you walk about from that situation, you’ll have gain owing to liability relief.

With that said, consider this Tax Basis Balance Sheet:

Assets = $0
Debt = $200k
Partner1 Capital = negative $100k
Partner2 Capital = negative $100k

Assuming the debt gets allocated evenly, each Partner’s outside basis is $0.

Now assume Partner1 dies. Assume the FMV of assets is $0 (or even anything less than $200k). If this debt is non-recourse, I believe our inside basis adjustment will be for the full $100k (i.e. the full negative capital account balance of Partner1). Inheritor’s outside basis will be $100k. Effectively, we’d debit assets $100k and credit Partner1 capital $100k. Pretend the debt secures the assets and there’s an immediate, post-death foreclosure. The partnership will have $200k of gain. $100k of it will be allocated to inheritor, but the inside step-up of $100k (to the benefit of the inheritor only) eliminates the gain to the inheritor. In this situation of non-recourse debt, the “selling price” can never be less than the amount of the debt.

But for purpose of the 743(b) adjustment and the calculation therein, I still take the full debt against the FMV of the assets, yes?

Of course you wouldn’t. But even if you did, you’d find that it’s neutral.

So the beneficiary inherits two items: a partnership interest with an FMV of $0 and debt of $100,000. The debt increases outside basis by $100,000. The effect is the same as if there were no debt but the partnership interest had an FMV of $100,000 and a capital account of $0. In either case, there is a $100,000 step-up.

That all makes sense, but why does the situation change with recourse debt? Is it because the beneficiary may not assume the debt in the first place due to not being liable for it? I can see that, but in the example you provided in #11, it seemed like the beneficiary would in fact assume the debt even though you assumed it was recourse debt.

Of course, based on the facts we now have for the OP's client, the 25% partner never had any debt basis in the first place, so none of this would apply. You mentioned that losses never should have been allocated — that may be, but it's possible there was a DRO and in that case losses could have been allocated. In that case, with no debt to add to the negative capital account and FMV, can we really say the inside and outside bases are anything other than $0?

If there was no DRO, the capital account is $0. Would that also be the outside basis, since even a "negative FMV" can't push basis below $0?

Re: their other partnership - the asset's FMV is less than the basis on the books. So when they sell this property they are upside down in (at the moment) and then close the LLC since it's only purpose is to hold the property then there will be a loss they cannot take and never will be able to take since there is no outside or inside basis?

The essential idea behind all of these rules is you can't lose more than you actually put in to the venture. So, if there is no deficit restoration obligation, then losses are no longer allocated to a partner once that partner has lost all the money they invested ($0 capital account). Under Regs. § 1.704-1(b)(2)(ii)(a), losses can be allocated to a partner if there is an economic burden that corresponds to the allocation. So, I think it is reasonable to allocate all of the losses to the partner who made the loan once the other partners reach a $0 capital account balance.

Also, my experience has been that these "loans" are actually contributions to capital in most cases, so I would just as soon shift the loan over to equity on the balance sheet and increase that partner's capital account. This would have the same effect.

In this scenario, your 25% partner, and possibly others, were allocated too much loss. Amended returns can be filed to allow the partner who bankrolled the operation to claim the additional losses, subject to the statute of limitations. When the operation is sold, any additional losses will also be allocated to that partner.

Chay that makes sense. What about the opposite - say the property were sold at a large gain in a couple years. Would profits allocations also change if the loan (which you say is capital) would clearly be generating the profits? Obviously, profits were the original intent.