New Partner Admitted - Capital Account Presentation

Technical topics regarding tax preparation.
#1
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Partnership admitted a new partner with a 20% P/L/E stake for $15M. The $15M is considerable higher than 20% of the capital of the partnership. In the past I would have balanced the partners capital accounts with the additional bonus, so if for example the partnership had to capital of $25M immediately before the admission the capital accounts would reflect 16M / 16M / 8M immediately after to represent the 40 / 40 / 20 split.

Now I am wondering if the same procedure should be followed since the capital accounts are reported on the a tax basis?

Any other advice on how to handle this situation, with a new partner admission and large capital investment in partnerhsip?
 

#2
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Well, the capital accounts not only need to be kept on a tax basis but also book basis (§ 704(b)). Failure to keep § 704(b) books is going to lead to a headache of epic proportion later down the road.

From a § 704(b) standpoint, there can be a revaluation and a book up of the capital accounts. From a tax standpoint, a § 754 election can be made if one is not already in place. I don’t know what assets are on the balance, but be aware of a possible reverse § 704(c).
Last edited by Verytaxing on 21-Jan-2022 9:07pm, edited 1 time in total.
 

#3
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From a tax standpoint, a § 754 election can be made if one is not already in place.

No, not on a capital contribution.

In the past I would have balanced the partners capital accounts with the additional bonus, so if for example the partnership had to capital of $25M immediately before the admission the capital accounts would reflect 16M / 16M / 8M immediately after to represent the 40 / 40 / 20 split.

No, that’s all wrong. If you had 2 existing and equal partners (A and B) and total capital was $25m (say on both a book and tax basis)…and then Mr. C comes along with a $15m contribution for a 20% stake…the implied value here is $15m divided by 20%, or $75m.

C would take a book and tax capital account for his contribution of $15m. (Since he contributed cash, we are not dealing with a forward 704c situation). A would get booked up to $30m (book basis). B would get booked up to $30m (book basis). Total book capital is now $75m. And (1) 15/75 = 20% (2) 30/75 = 40% (3) 30/75 = 40%.

It’s a reverse 704c situation as Verytaxing points out.

A has a book/tax difference of $17.5m ($30m vs. $12.5m). Ditto for B.

This is a pretty straightforward scenario, since there are no pref’s (as far as we know), so there’s no real waterfall we have to deal with. But you nonetheless will have to deal with the disparities. See the -3 Reg.
 

#4
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Jeff-Ohio wrote:
From a tax standpoint, a § 754 election can be made if one is not already in place.

No, not on a capital contribution.


Thanks Jeff, mea culpa. I forgot the new partner was not purchasing.
 


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