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How do I report depreciation for property contributed by partners?


David

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2 taxpayers had schedule C businesses in 2016 and formed an LLC in November 2016. They both contributed equipment and other fixed assets to the LLC.

I know that the partnership steps into the shoes of the partners as far as depreciating the assets. How is this reported on the asset entry worksheets? Do I use the partner's original purchase date, purchase price, accumulated depreciation, etc.? I don't see how depreciation would be continued without entering the original information.

However, I'm not sure a purchase date can be entered that is prior to the LLC formation date.

How have those of you who had this issue handled it?

Thanks for your help.

 

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Depr schedule continues as was from individuals.  LLC books depr schedule assets at original cost and accumulated depr accounts balances.  Then the fair market (or agreement price) value minis the net book value of depr schedule is booked as a non-depr asset like land.  

Yes original dates can normal be entered in most software.

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Whatever happened to "Inside Basis" and "Outside Basis?"  Do I have this confused with something else?

"Outside" basis is tracked by the partner and not the partnership.  It retains its original cost and accumulated depreciation at the time of the asset contribution.  The depreciation continues for the duration of its remaining depreciable life.

"Inside" basis is tracked by the partnership and not the partner.  It is recorded on the books of the partnership at its FMV at the time of the asset contribution, which is usually higher than the adjusted book value of the asset on books of the partner.  The partnership applies depreciation on the FMV as if it had been purchased from a disinterested party.

The varying dollar values will create a natural difference between the inside vs outside basis for as long as annual depreciation continues on either books.  The difference should be tracked by a competent tax preparer for as long as the difference exists.  When asset is fully depreciated, the difference will cease to exist.

If subject asset is disposed within a prescribed time limit (7 years I think, but they keeping changing it), a special allocation is made to the contributing partner on the K-1, and the original owner must recognize full capital gains/recapture on his/her own return.

By all means charge extra money for this extra work.  In fact, inform the partners that contributions of assets instead of cash will result in higher fees.  Remember, most partnerships do not last very long - often beginning with two dufus-looking guys showing up in your office and saying "Duh...we're sorta partners" and six months later they hate each other.  Contributions of equipment in lieu of cash are perfectly legal, but in many cases is prompted by a cash shortage of one of the partners.

Am I cornfused about the treatment described above?  Won't be the first time...does the treatment differ for an LLC if reporting as a partnership?

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Edsel, You are so on point about so many things here.  Especially the point about "... most partnerships do not last very long ..." and "... six months later they hate each other."  My now former clients fit this description to a T.  They thought they were so clever to have the partnership (LLC but they didn't know it would be a partnership - duh) agreement prepared by an attorney who knew nothing about basis.  One partner provided $200,000 cash, the other fully depreciated equipment originally valued at $200,000.  It was bad enough when I explained the tax ramifications initially but guess which one was furious when the K-1's were prepared and the tax deductions were so different on their individual returns.

I vowed no more partnerships after that.  It was ugly.

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Margaret, for what it's worth, don't give up on doing partnership returns.  If you do, you'll lose both experience and expertise.  As fleeting as partnerships may be, there are some that you can perceive from the outset will have responsible and somewhat knowledgeable partners.  A good clue is whether they are willing to spend the effort to draft articles of partnership, or similar agreements in the case of LLCs.  If they are not willing to do this, the proof already exists that your engagement will be one of misery and possibly not even be able to collect your fees.

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Thanks for the support but I am in near retirement mode now.  This incident was several years ago and I primarily do only individual returns for long time clients.  There are a few Sch. C's and 2 partnership LLC's that do not have these issues but I won't be taking on more.

I was just reinforcing your comments about basis issues and partnership wrinkles in general.  They do exist and can be pretty unpleasant!

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On ‎7‎/‎13‎/‎2017 at 6:03 AM, Edsel said:

Remember, most partnerships do not last very long - often beginning with two dufus-looking guys showing up in your office and saying "Duh...we're sorta partners" and six months later they hate each other. 

The last one I suffered through was a retail venture with two high maintenance bored ladies.  I discouraged them from setting up a partnership.  A lot.  But they acted like I would do the bookkeeping, so how bad could it be?  Well, guess what?  High maintenance bored ladies need manicures and stuff like that more than bookkeeping as it turns out.  Pssshh. we have a computer we'll just keep these little ole books do you love my glitter nail?  Yes, six months. 

The "we're sorta partners" dufus guy came in about a month ago asking about bookkeeping fees.  He was all of 120 pounds, and they were opening a security agency.   He looked like he's never had a bank account.  You know that look.  And you know, 120 pounds.  I wanted to give him half my sandwich.

Sorry I'm all booked up, but good luck!  I hope he was the brains of the outfit and the other guy at least weighed more than me.

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On ‎7‎/‎13‎/‎2017 at 6:03 AM, Edsel said:

Whatever happened to "Inside Basis" and "Outside Basis?"  Do I have this confused with something else?

"Outside" basis is tracked by the partner and not the partnership.  It retains its original cost and accumulated depreciation at the time of the asset contribution.  The depreciation continues for the duration of its remaining depreciable life."

*Agree there are always inside basis and outside basis in ANY organization other than a proprietorship.

"Inside" basis is tracked by the partnership and not the partner.  It is recorded on the books of the partnership at its FMV at the time of the asset contribution, which is usually higher than the adjusted book value of the asset on books of the partner.  The partnership applies depreciation on the FMV as if it had been purchased from a disinterested party."

*I disagree with the partnership depreciation at FMV.  That would result in the partner K-1 under reporting taxable income.  The recording of FMV is to show agreed value of partnership ownership and reporting of income/loss. Example: Partner-1 contributes 100,000 cash, Partner-2 contributes Equipment valued at 100,000 (book value 10,000) for 50-50% ownership and 50-50% profit/loss. Partnership 1065 depr is only based on $10,000 due to non-churn rules.  Remember a Partnership is only 2 or more proprietorships.

"Am I cornfused about the treatment described above?  Won't be the first time...does the treatment differ for an LLC if reporting as a partnership?"

*LLC is disregarded, taxed status rules.  If its 2 or more its taxed as a Corp or Partnership.

 

 

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  • 2 weeks later...

Is the difference between FMV and net book value reported on the depreciation schedule or is it only recorded as a non-depreciable asset on the books? If the difference per asset is recorded on the depreciation schedule as non-depreciable, the amount will be considered as part of the gain/loss when the asset is sold. This doesn't seem correct to me.

Am I off base here or is my understanding correct on how to actually handle this situation?

Thanks for your help.

 

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Ok, maybe my questions wasn't clear and didn't make sense. Let's try this.

Based on my research it appears that the partner gets basis for the NBV of assets contributed and gets capital contribution amount for the FMV  of assets contributed. Is this correct?

So if a partner contributes property with a FMV of $400K and NBV of $100K how is this reported on the tax return, especially the balance sheet?

Is it the following?

Fixed assets at NBV and depreciation continues as was when in the partner's hands.

The excess of FMV vs NBV is recorded as fixed assets but not depreciated. Or is this recorded as Other Assets?

FMV of assets recorded as capital contribution.

Therefore the balance sheet will be reported as follows:      DR                                  CR

Fixed Assets (only $100K depreciated)                               $400K

Partner Capital                                                                                                             $400K

 

The partner basis statement will show basis as $100K (not sure why the basis wouldn't be $400K).

 

Thanks for clarifying this for me.

 

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David, Old Jack gave you the answer in his very first post. I used hypotheticals for the historical cost of $250K and accumulated depreciation of $150K that you didn't supply, but that arrives at the $100K NBV you mention. In this case the entry would be:

  • Debit of $250K to the Fixed Asset account for the original depreciable basis from the Sch C
  • Debit of $300K to the Fixed Asset account for the excess of FMV $400K over the $100K of current NBV transferred in.  This is a nondepreciable cost on the fixed asset schedule.
  • Credit of $150K to the Accumulated Depreciation account for the amount already taken by the Sch C
  • Credit of $400K to Partner Capital

You might find this article interesting and helpful so you know how to handle the allocations to the partners in the future:  Contributions of Appreciated Property to a Partnership: More Than Just a Nice Credit to the Capital Account

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Thanks, Judy.

I guess I am confused by the basis vs. capital credited to the contributing partner. Everything I read says that the partner get basis for his basis in the property. Even the article you attached states this:

Quote

For a contribution of property in exchange for a partnership interest that does not involve any recognition of gain by the contributing partner, the partnership takes a basis in the contributed property equal to the contributing partner’s basis in the property, and the contributing partner takes a basis in his partnership interest equal to his or her basis in the contributed property.

 

So in your example does the partner have capital of $400K and basis of only $100K? Or does he have capital and basis of $400K?

Thanks for your help.

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54 minutes ago, David said:

the contributing partner takes a basis in his partnership interest equal to his or her basis in the contributed property.

Yes, ^ that is the answer!  In your client case, the contribution of the property didn't trigger gain recognition so the partner's basis in the partnership is equal to his adjusted basis in the property contributed.   The partnership's basis in contributed property equal to the FMV though.

 

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Judy,

Thanks for your help on this. 

So my earlier statement that the Partner's capital is $400K and his basis is $100K is correct? I previously thought the capital attributed to the partner and the basis attributed to the partner had to be the same for contributed property.

Thanks.

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David, You are confusing inside basis with outside basis.  The partnership books would show that the partner has $400 basis per your example but the Partner as an individual (his 1040 tax return) only has a basis of $100.  If the partners share of losses, as an example, was $400 loss he would have a zero basis as far as the partnership books was concerned but he could only deduct $100 loss on his 1040 and resulting personal basis therefore zero.  Remember that in any organization other than a proprietorship there is always and inside basis and an outside (personal) basis.  A partnership is complicated. lol

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