I have a research paper and have done it (See attached). I have also attached the questions my client (4 partners) has. So, I need a 2 pages client letter/memo to my client, who are 4 partners in the partnership, explaining to them the questions. Note that: These questions I have answered in the research paper. You need to refer to that to write a client letter/memo.
See attached for the additional documents.
As a result of a significant slowdown in economic activity,
your client the Bronx Bombers, LLC needs additional capital to maintain the property and make payments on the mortgage. The LLC has four partners. Ruth, DiMaggio, Jackson and Berra, are all equal partners. Currently the debt is non-recourse. The Bronx Bombers want to admit Jeter to the LLC. They want him to invest $3,000,000 for a 20% interest on January 1, 2023.
Additional information is:
Admittance of Jeter to the partnership for a 20% interest for $3,000,000.
A revaluation of the partnership under 704(b).
Guarantee of the debt by Jeter.
The partnership agreement calls for a 10% preferred return on capital contributions. Currently, no original capital has been distributed back to the partners.
The depreciable life of the building is 39.5 years. The building has been depreciated for 10 years through 12/31/2021.
The loan had previously be refinanced and the excess proceeds distributed.
You client wants to know the following:
What is the best 704(c) allocation method and why? How much tax depreciation you client get?
Upon admittance, how will the debt be allocated and how much debt will be allocated to each member?
Will there be any gain on the transaction as a result of the changes in the debt allocation? Why?
How does the revaluation of capital accounts impact the liquidation of the partnership?
What are the capital accounts and debt amounts allocated to the members at the end of year 1 using the 704(c) method identified above? 1
12
Tax Research Paper
Students Name:
Course Name:
Institution Affiliation:
Abstract
In this tax study paper, Jeter, a new partner, is admitted to the Bronx Bombers, LLC partnership. This partnership is having financial problems and requires additional funding to preserve its assets and pay its mortgage. On January 1, 2023, the partnership intends to accept Jeter, have him contribute $3,000,000 for a 20% interest in the business, and have him guarantee the loan. The partnership must allocate the debt upon Jeter’s admission to the partnership and choose the best 704(c) allocation method for tax depreciation purposes in order to ensure correct tax treatment. The paper also examines whether the transaction will result in any gains due to adjustments in debt allocation and how the partnership’s liquidation would be impacted by the revaluation of capital accounts.
According to the research, the 704(c) allocation should be done using the conventional technique, and Jeter’s debt should be allocated based on his capital contribution and preferred return. The study comes to the conclusion that in order to ensure that all partners profit fairly from the transaction, thorough examination of the tax consequences and debt allocation is required. To ensure the financial stability and success of the partnership, the partnership should frequently examine the partners’ individual capital and debt allocations and update the partnership agreement to reflect changes in capital accounts.
Introduction
Ruth, DiMaggio, Jackson, and Berra are the four equal partners in the limited liability business known as the Bronx Bombers, LLC. Cash, a structure, land, and other assets make up the company’s assets, whereas a bank loan makes up its liabilities. A considerable downturn in economic activity is evident in the company’s financial records for the year ended December 31, 2022, necessitating the need for additional funds to maintain the property and make mortgage payments. The Bronx Bombers intend to have Jeter join the LLC and make a $3,000,000 investment for a 20% interest on January 1, 2023 in order to address this problem. With Jeter’s admission, the partnership will also be revalued in accordance with section 704(b), and Jeter will guarantee the debt.
The partnership agreement also stipulates a preferential return on capital contributions of 10%. This study will respond to a number of inquiries from the Bronx Bombers regarding Jeter’s membership in the LLC. First, it will decide which 704(c) allocation method is best and figure out how much tax depreciation the corporation may write off. Second, it will go over how and how much debt will be distributed among the members if Jeter is admitted. Additionally, it will assess if the adjustments in the debt allocation will result in any transactional gains. This essay will also discuss how the partnership’s liquidation will be impacted by the revaluation of capital accounts.
The capital accounts and debt amounts assigned to the members at the end of year 1 utilizing the aforementioned 704(c) approach will also be provided. In conclusion, the hiring of Jeter by the Bronx Bombers, LLC gives the business a chance to secure the funding it needs to maintain its property and make mortgage payments. To guarantee that all partners profit equally from the transaction, however, this acknowledgment necessitates careful consideration of the tax implications and debt allocation.
Facts
The Bronx Bombers, LLC, a partnership with four equal partners named Ruth, DiMaggio, Jackson, and Berra, is the subject of this tax study report. The partnership is having trouble making ends meet and requires more money to maintain its assets and pay its mortgage. On January 1, 2023, they intend to welcome Jeter as a new partner. Jeter will contribute $3,000,000 in exchange for a 20% stake in the business. The partnership agreement stipulates a 10% preferred return on capital investments, and Jeter will guarantee the loan. The partnership must choose the optimal 704(c) allocation method for tax depreciation purposes and the amount of tax depreciation they will get in order to ensure correct tax treatment.
Additionally, they must decide how to distribute the debt after Jeter joins the partnership and assess whether the transaction will result in any gains as a result of the new debt distribution. The structure has also been depreciated for ten years through 12/31/2021, and its depreciable life is 39.5 years. Excess funds from the refinancing of the debt were dispersed. The partnership’s liquidation will be impacted by the revaluation of capital accounts. The effects of adding a new partner, reassessing capital accounts, and assigning debt for tax reasons must all be properly taken into consideration by the partnership. The partners should examine their respective capital and debt allocations on a regular basis, and they should update the partnership agreement to reflect the changes in capital accounts. The Bronx Bombers, LLC partnership’s financial stability and success will be guaranteed by careful planning and handling of these issues (Klitgaard, 2018).
Issues
The Bronx Bombers, LLC partnership raises several significant tax difficulties in the tax research paper. Before anything else, the partnership must choose the best 704(c) allocation method and calculate how much tax depreciation it will be entitled to. In order to do this, partnership assets must be revalued, and the basis disparities that arise must be distributed among the partners. The partnership must carefully weigh all available 704(c) approaches, including the traditional way, the remedial technique, and the curative allocation method, in order to choose the one that will provide the most favorable tax treatment. The partnership must allocate the debt after Jeter is admitted to the partnership in order to see if there will be any gains from the transaction as a result of the changes in debt allocation. A 10% preferred return on capital investments is stipulated in the partnership agreement, and Jeter will guarantee the loan (Oei & Osofsky, 2019).
The effects of the 10% preferred return on capital contributions as well as the tax ramifications of the debt allocation, including any potential gain recognition, will need to be taken into account by the partners. Third, the building has been depreciated for ten years as of December 31, 2021, out of its 39.5-year depreciable life. In order to account for any changes in basis brought on by Jeter’s admission to the partnership, the firm must compute the proper tax depreciation for the building for the remainder of its depreciable life.
At some point, the partnership will have to take into account how revaluing capital accounts may affect the partnership’s eventual dissolution (Goldberg, 2021). The distribution of liquidation funds upon the end of the partnership will be impacted by the revaluation of capital accounts. The partnership agreement will need to be reviewed and updated by the partners to account for any changes in partnership interests as well as the capital accounts that emerge from Jeter’s admission to the partnership.
Analysis for Questions
The best 704(c) allocation method
The standard approach would be the most effective 704(c) allocation strategy for Bronx Bombers, LLC. This is due to the fact that all partners receive an equitable distribution of tax depreciation based on their capital contributions. The partners who contributed to the partnership at the time of the revaluation get the built-in gain or loss on the assets under this technique. The capital accounts of the partners are then changed to reflect the fair market value of the assets. In this instance, Jeter’s $3,000,000 capital contribution makes up 20% of the entire capital of the firm. The assets of the partnership will have a built-in gain or loss that will be distributed among the partners in accordance with their capital contributions.
Based on his 20% capital input, Jeter will receive a portion of any gain or loss that is built in. The allocated basis of the depreciable assets will determine the amount of tax depreciation that Bronx Bombers, LLC can claim. According to the conventional technique, the assigned basis is determined by the assets’ fair market value at the time of revaluation. In other words, the partnership will be entitled to deduct tax depreciation based on the assets’ allocated basis. In this instance, the building has a 39.5-year depreciable life and has been written off for 10 years as of 12/31/2020. The structure has 29.5 years of depreciable life left. The building cost $5,000,000 to construct and has accrued $1,265,823 in depreciation.
So, $5,000,000 minus $1,265,823 is $3,734,177 for the building’s adjusted basis. If the building is the only depreciable asset and its allocated basis is $3,734,177, then Bronx Bombers, LLC can deduct $94,531 in taxes per year using the straight-line method ($3,734,177/29.5 years), assuming that the building is the only depreciable asset. As a result, the traditional technique produces a fair allocation of tax depreciation based on capital contributions, making it the optimal 704(c) allocation method for Bronx Bombers, LLC. Based on the assigned basis of the depreciable assets, the partnership will be eligible to claim tax depreciation; the building will receive an annual tax depreciation of $94,531 as a result.
Debt Allocation & How Much
The debt of Bronx Bombers, LLC shall be divided among the partners upon admission in accordance with their capital contributions. Jeter’s $3,000,000 capital commitment makes up 20% of the overall partnership capital. Jeter will therefore be given 20% of the debt, which is presently $5,200,000. As a result, Jeter will be liable for the remaining debt of $1,040,000. Ruth, DiMaggio, Jackson, and Berra are the remaining partners, and they each own 20% of the company. Each will receive 20% of the $1,040,000 total debt as their share. They will each be liable for $208,000 of the bill, according to this.
It’s vital to remember that the debt is now non-recourse, which means that in the event of failure, the lenders would only be able to use the property as collateral. Jeter will be held personally liable for the loan’s repayment in the event that the partnership defaults due to his guarantee of the debt. In conclusion, upon admission, Jeter will be given a debt allocation of $1,040,000, equal to 20% of the $5,200,000 total debt. Each of the remaining partners will receive 20% of the debt, for a total debt allocation of $1,040,000. In the event that the partnership defaults on the loan, Jeter will be personally liable for its repayment (Tunnell & Ricketts, 2018).
Gain on the transaction
The modifications in the debt allocation will result in a gain on the transaction, hence the answer is yes. The partnership’s adjusted tax basis in its assets is compared to the fair market value of those assets at the time of the transaction to determine any gain or loss. The Section 704(b) book-up or book-down is what this is known as. The partnership will be revalued in accordance with Section 704(b) when Jeter enters to account for his capital contribution and the distribution of debt. The revaluation will raise or lower the tax basis of the partnership’s assets in accordance with their fair market value, depending on whether it is done.
There will be a book-up adjustment, which will raise the partnership’s tax basis in its assets, if the fair market value of the partnership’s assets is higher than their adjusted tax basis. Future years may see lower taxable income as a result of bigger depreciation deductions brought on by the higher basis. In contrast, a book-down adjustment, which lowers the partnership’s tax basis in its assets, will occur if the fair market value of the partnership’s assets is lower than their adjusted tax basis. Future years’ taxable income may increase as a result since depreciation deductions will be reduced due to the lower basis.
Given that Jeter’s capital contribution and the distribution of debt will raise the partnership’s total tax basis in its assets, a book-up adjustment is probably in order in this scenario. Future years’ taxable income will be reduced as a result of the partnership’s ability to deduct more for depreciation thanks to the greater basis (Borden & Longhofer, 2021). Depending on the difference between the assets’ adjusted tax basis and fair market value, adjustments in debt allocation following Jeter’s admission will often result in a gain or loss on the deal. In this instance, a book-up adjustment is most likely to occur, which will lead to higher depreciation deductions in the future and a decrease in taxable income.
Revaluation of Capital Accounts impact the Liquidation of the Partnership
The distribution of profits and losses to partners as well as how capital accounts are valued can all be significantly impacted by the revaluation of capital accounts in a partnership. The capital account balances of all partners will alter as a result of the admission of Jeter and the reassessment of the partnership’s assets under Section 704(b) in the instance of the Bronx Bombers, LLC. Each partner’s proportionate share of the partnership’s assets, liabilities, and income is shown in the capital accounts. The distribution of capital account balances to the partners during the partnership’s liquidation is standard practice.
It may benefit the partners during liquidation if the partnership’s assets are revalued in a way that raises the total balance of the capital accounts. When the partnership’s assets are sold or any outstanding liabilities are settled, they will get a bigger portion of the money. On the other hand, if the revaluation causes the total capital account balances to decline, this could hurt the partners upon liquidation. If the partnership’s assets are sold or any outstanding liabilities are settled, their portion of the proceeds will be reduced. It is significant to remember that the revaluation of capital accounts could also cause gains or losses to be distributed to the partners.
Typically, the capital account balances of the partners serve as the basis for allocating gains and losses after liquidation. The partnership agreement is then used to determine how to share any remaining gains and losses. The Bronx Bombers, LLC partnership agreement stipulates that no original capital will be returned to the partners and that a 10% preferred return on capital contributions will be made. As a result, any gains or losses during liquidation will be distributed based on the balances of the capital accounts held by the partners, with any remaining gains or losses being distributed in accordance with the partnership agreement. Generally speaking, the revaluation of capital accounts can have a big impact on how a partnership is liquidated, especially in terms of how the partners are paid out and how any gains or losses are divided. To make sure they are appropriately prepared for any prospective adjustments, partners should carefully analyze the potential effects of any revaluations and engage closely with their tax and legal consultants (Lessambo, 2021).
Capital Accounts and Debt Amounts
We can apply the previously mentioned 704(c) technique to assign the newly admitted member’s basis to the existing assets in a manner that reflects their fair market worth. Therefore, if Jeter had been a partner for the full year, we would need to figure out how much depreciation would have been applied to his share of the partnership’s assets. We must first ascertain the building’s adjusted basis before we can calculate depreciation. The building was originally purchased for $5,000,000, and as of 12/31/2020, it has accumulated $1,265,823 in depreciation over the past 10 years. The building’s adjusted basis will therefore be $3,734,177 at the start of 2022.
Jeter’s 20% partnership stake means his capital account gets 20% of the annual building depreciation, instead of the usual 10%. To calculate, the building’s adjusted basis of $3,734,177 is divided by its remaining depreciable life of 29.5 years, giving a yearly depreciation expense of $115,190. So, Jeter covers $23,038 (20%), with that sum going to his capital account. His total contribution of $3,000,000 means his capital account balance at year-end is $3,023,038 ($3,000,000 + $23,038). Jeter will serve as a guarantee for the partnership’s $5,200,000 total debt. With Jeter’s contribution, the remaining debt will be shared by the remaining partners at a lower rate, with each partner now bearing 20% of the burden.
As a result, the following debt amounts are assigned to each member at the conclusion of the year:
Ruth: $5,200,000 x 20% = $1,040,000
DiMaggio: $5,200,000 times 20% is $1,040,000
Jackson: $1,040,000 ($5,200,000 x 20%)
Berra: $1,040,000 ($5,200,000 x 20%)
Jeter: $3,200,000 (20% of the debt plus his $3,000,000 capital investment) (Borden, 2019).
According to the previously mentioned 704(c) method, Jeter will ultimately have a capital account balance of $3,023,038 at the end of the year, with Ruth receiving $1,040,000 in debt, DiMaggio receiving $1,040,000, Jackson receiving $1,040,000, Berra receiving $1,040,000 in debt, and Jeter receiving $3,200,000 in debt.
References
Borden, B. T. (2019). Partnership-Related Relatedness: Measuring Partners’ Capital Interests and Profits Interests.
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Borden, B. T., & Longhofer, D. L. (2021). Rethinking Book-Tax Disparities and Partnership Distributions.
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Goldberg, D. S. (2021). ” Partnership Revaluations: Book-Ups Are Your Friends (Usually)”–Planning with Revaluations and Their Interplay with Section 704 (c).
Tax Lawyer,
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Klitgaard, R. (2018). Evaluation of, for, and through Partnerships. In
Evaluation & Development(pp. 43-58). Routledge.
Lessambo, F. (2021).US Taxation of Partnerships: Advanced Topics.
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Oei, S. Y., & Osofsky, L. (2019). Legislation and Comment: The Making of the Sec. 199A Regulations.
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Tunnell, L., & Ricketts, R. (2018).Advanced tax strategies for LLCs and partnerships.
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