Goodwill. Hot Assets?

[Corduroy Frog]

I don't know how to ask this question quickly without creating a test sample:

BarryCross,Surveyor joins a real estate development partnership, and brings with him all his assets, including $40,000 of unamortized goodwill.  Eight years later the partnership is sold for a substantial gain, and during the eight years the unamortized goodwill has dropped to $28,000.  Which of the following, if any, best describes the treatment.

1. Barry's K-1 should indicate his proportionate share of the gain, his basis includes the $28,000 of unamortized goodwill.
2. Barry's K-1 should indicate his proportionate share of the gain, his basis includes $40,000 of goodwill, because he has not been able to deduct the $12,000 amortization which has transpired.
3. There is no recognition of the goodwill because the sale has exceeded the five year statute for "hot" assets.
4. Barry could not have transferred the goodwill into the partnership to begin with because it is not a tangible asset.
5. Any gain/loss on the goodwill should have been calculated upon entry into the partnership and no further recognition.
6. Goodwill cannot be transferred into the partnership, and any gain/loss upon entry is forgone.
7. None of the above.

Sorry for my ignorance, I could never research this subject on my own.  Thanks to any of you who volunteer an opinion.

[Catherine]

Don't know off-hand.  There was a big presentation on this topic a year ago and if I get a chance I'll haul out my notes and see if there's anything useful.

[Corduroy Frog]

This came up in a seminar a couple weeks ago, and no one could wrap their arms around it.  The presenter spoke confidently but was not successful imparting anything clear.  Even my multiple choices above are all over the map.

[DANRVAN]

There is not enough information given.

Was an FMV assigned to the goodwill on date of transfer eight years ago greater than basis of contributing partner?

If so, was amortization properly allocated per reg 1.704-3(b)?

Assume post 1993 transfer.

No related parties?

[ILLMAS]

A good start is reviewing enrolled agent exam part 2 study materials, you might find a similar example in there.

[Corduroy Frog]

Thanks for the responses - I've been out for a few days.

I'm not sure I gave out the perfect example, but please just assume mainstream events.  Assume amortization is correct and goodwill was properly calculated.  No additional information for exotic events.  The subject matter (it seems to me) is convoluted enough as is and I don't have a clue.  I might access the enrolled agent exam if I knew where to find it.  I passed that thing 12 years ago...

 

[Max W]

This looks like it may be a good place to start.  It gives 4 different scenarios with bookkeeping entries.  Your case is simpler as there are only 2, not 3 persons involved.

https://www.yourarticlelibrary.com/accounting/partnership-account/admission-of-a-partner-goodwill-revaluation-and-other-calculations/54425

 

[DANRVAN]

On 11/28/2020 at 11:50 PM, Corduroy Frog said:

Eight years later the partnership is sold for a substantial gain, and during the eight years the unamortized goodwill has dropped to $28,000.

 

On 12/3/2020 at 6:55 PM, Corduroy Frog said:

Assume amortization is correct

The key here is proper allocation of the contributed goodwill.  If that has been done then gain will properly flow from from the basis of partnership capital accounts upon sale/liquidation of the partnership, or sale of the contributed asset.  

There is no special tax rule for contributed goodwill, it is treated like any other 704(c) property which the amortization or depreciation is allocated to the partners under reg 1.704-3(b) in respect to a Built in Gain.

The allocation is made to prevent disparity between the book and tax capital accounts of the non-contributing partner as well as to prevent shifting of tax attributes among partners.  Basically, the contributing partner recognizes the built in gain over the remaining life of the asset through a reduction in the amount of amortization  or depreciation allocated to him.

Here is a basic example where A and B form a 50/50 partnership.  A contributes goodwill with fmv of 10,000 and basis of 5,000 = BIG of 5,000. 

B contributes 10,000 in cash.

The built in gain is reflected in the difference of A's book capital account of 10,000 and tax capital account of 5,000; while B has a 10,000 balance in both book and tax capital accounts.

Now assume the contributed asset has 10 years remaining life.  Therefore the book amortization is 1,000 and tax amortization is 500 for the partnership.  The book amortization is allocated 50/50; therefore each partner receives 500 in book depreciation.

However, under the reg, the tax amortization  is allocated first to the non-contributing partner B in an amount equal to his book amortization  of 500.

Therefore in this case, B is allocated the entire 500 of tax amortization  and A receives zero.

Now look at the effect on A's capital accounts.  His book capital account has been reduced from 10,000 to 9,500 by amortization  while his tax account remains at 5,000 since he was not allocated any amortization for tax purposes.  

So now the amount of BIG reflected in the difference between A's book and tax capital account has been reduced to $4,500.  

If you fast forward the calculations to 5 years his BIG will be reduced in half to 2,500 and at the end of the ten year life of the asset, he will have recognized 100% of the BIG through his reduced allocation of amortization.

While that was a simple example it can get a lot more complicated and additional rules kick in.  For example there might be not be enough income to cover partner B's amortization; or there might not be enough tax amortization to cover B's book depreciation.   Those situations are covered in the reg.

Now in answer to your question, when the partnership is sold, any remaining BIG will be recognized by the contributing partner as a difference in book/tax capital accounts; provided amortization or depreciation has been properly allocated.  If not you have "BIG" PROBLEMS to resolve.

On 11/28/2020 at 11:50 PM, Corduroy Frog said:

None of the above.

That is the correct answer!

[DANRVAN]

2 hours ago, Max W said:

This looks like it may be a good place to start. 

That article covers a different topic.  It addresses issues with allocating existing goodwill to newly admitted partners in profit sharing.   

Appears the discussion is purely from an accounting standpoint.

 

 

[Corduroy Frog]

Thanks to all who have hung in there with me.  DANV you took the time to paint a very good picture of how such a situation should be treated, and I am very appreciative.  Much of the cobwebs in my head were removed as a result.  A great discussion for "inside and outside" basis/capital.