Personal home on partnership books

Our firm has engaged with a 5 partner partnership. All are related.

They have a personal home used by one of the partners on the books. This was recorded about 5 years ago. It has never been depreciated, and it doesn't appear that they have ever deducted expenses through the partnership. They were treating as an investment property. The brother lives there with his family.

After further research, this property is actually owned in the name of the brother (who is living there), not the partnership. All the partners are fine with this. This brother is the only US citizen, the others are all nonresident aliens, if that has any consequence.

It was originally recorded on the books as a debit to "House" and credit to cash.

We are trying to determine how to handle. Do I propose to write off as a distribution at book value, or do I need to distribute at fair value to the brother? The estimated market value is $1 million, the book value is $600k. Any other options?

Thanks so much for any guidance.

When it first went on the books as a debit to house and a credit to cash, were they buying it from a 3rd party?

So 5 years ago, the partnership had cash to pay for the house that belongs to one oartner. This may have been a gift. Or a distribution back then. Or did the cash really come from the partner who lives in the house?

I assume the partnership has other operations, or investment activities?

Are the P/L sharing and the capital entitlement spelled out in the agreement, and did they change when the partnership bought one partner a house?

Thanks Nilo.

Yes, bought from unrelated party.

They had cash to pay for it. So it was probably recorded in his name, but intended for the partnership. The deed just never changed.

Yes they own gas station buildings for the most part and other investment condos. Those properties are all run correctly with non-related fair value rent charged.

Yes P&L sharing and capital all spelled out and no official document changed. I am sure I can get an addendum to partnership agreement stating the distribution would be out to all partners if we need to go that route.

They had cash to pay for it. So it was probably recorded in his name, but intended for the partnership. The deed just never changed. And partnership pays all the costs and expenses of the home? (Not per OP). And charges no rent or interest? (As per OP). I have trouble seeing that as anything other than gifts when they bought it and each year, or distribution when they bought it and each year. Is there anything that would support that there is a loan to partner?

I am sure I can get an addendum to partnership agreement stating the distribution would be out to all partners if we need to go that route.. That's even stranger. That implies it's really a partnership asset but yielding no return. And don't even mention what will happen if/when it's sold one day and brother wants the 121 exclusion.

I'm confused because OP seems to say the partnership substantively owns it, but some actions (title, no rent or interest, no expenses) imply otherwise. They need to decide what they mean.

No loan to partner.

This partner does not anticipate the 121 exclusion.

So I think they either have to deed to partnership and move him out or charge fair rent, or count as distribution to this partner which would create negative capital and a distribution in excess of basis.

This partner does not anticipate the 121 exclusion.

That's kind of bizarre given the facts. Why not?

I agree with Nilo, you need to divine intent. Then you need to reconcile what has transpired to intent. I've read through your posts twice and I still don't fully understand what is going on.

Okay, thanks ManVsTax, sorry for the confusion. I got some more info.

Their intent was to deed it to the partnership, but they never got around to it, and then forgot about it.

So let's say they agree to get it titled in partnership name, but they refuse to make partner (the youngest brother and only U.S. citizen) pay rent at fair value or move out, what are the options?

What if they don't re-title property? Do I need to let them know they need to distribute at book value since it appeared to be a distribution to partner?

Right now you have (presumably) a homestead exemption on the property, Sec 121 exclusion upon a sale, and minimal administrative overhead.

I understand their intent was to deed it to the partnership. I'm more concerned with their intent for the property after that intended event. Surely most partnerships, if they intended to hold the property for an investment would not let the brother live in it.

I think the original journal entry should have hit distribution and cash, not property and cash.

I'd want to explore the possibility that the other siblings made gifts of cash to the brother so that he could purchase the property, or have unrecorded notes against the property. The overall substance of the dynamic does not point to an investment property owned by the partnership, and I don't know forcing that at this juncture is optimal.

Sounds like a money laundering scheme.

At some point someone will bring this up, so I'll do it now. They'll assert that the property will be going up in value and the partnership is holding it as an investment and the U.S. partner who occupies it is merely the caretaker/custodian of this valuable investment. And they are certainly aware of and in compliance with section 1446. And since it's merely an investment property that produces no current income, surely they should not be depreciating it.

Thanks all. I believe I will need to get client in contact with some more advanced help. Really appreciate all the guidance.

What if they don't re-title property? Do I need to let them know they need to distribute at book value since it appeared to be a distribution to partner?

I think the original journal entry should have hit distribution and cash, not property and cash.

Depending on actual numbers, I think OP needs to be very careful about treating this as a distribution, whether now or iin some earlier year.Statute of limitations comes to mind; maybe 6 years.

Okay an update:
Nothing final, but we are in talks with a tax attorney, and off the top of his head he thought about the following:

1. Doing a corrective deed to deed the property to the partnership.
2. Imputing rent for the 6 years with an offset to the tenant/partner "Partner Draw" account. This would create distributions in excess of basis.
3. I would guess that would lead to preparing a form 3115 and recording depreciation.
4. There are also improvements the partner who has resided in this rental had made in the range of $100k. They were trying to decide if this could be added to offset the distributions.

We are to discuss again Friday. Any thoughts on any of these? Thanks all!

1. Sounds reasonable if factual, i.e., would it be correcting to what was intended 5 years ago, or just something done now to avoid unexpected tax problem?

2. Also reasonable, but 6 years takes you into closed years. Unless you can justify treating it as imputed on some sort of catch-up basis, to correct an oversight, like the oversight in #1.

3. Yes.

4. Sure, same idea as #1 - a correction.

Now that you're imputing rent revenue to the partnership, how does that affect the foreign withholding requirements given four out of five partners are nonresident aliens?

Do the four NRAs need to file or amend 6 years of 1040-NRs each?

Nilodop said: Sounds reasonable if factual, i.e., would it be correcting to what was intended 5 years ago, or just something done now to avoid unexpected tax problem?

It was intended to be done this way from what they tell me.

Nilodop said: Also reasonable, but 6 years takes you into closed years. Unless you can justify treating it as imputed on some sort of catch-up basis, to correct an oversight, like the oversight in #1.

I am hoping to find a way to do it all in current year and not amend prior partnership returns.

ManVsTax said: Do the four NRAs need to file or amend 6 years of 1040-NRs each?

I am hoping to find a way to report all 8805 requirements in 2021.

Like the client said, it can't be the first time someone messed up so badly, surely we can correct it the best we can, and move forward doing it right.

Thanks so much for helping with this!