Sean, Penelope, and Juan formed the SPJ partnership by each contributing assets with a basis and fair market value of $200,000. In the following year, Penelope sold her one-third interest to Pedro for $225,000. At the time of the sale, the SPJ partnership had the following balance sheet:BasisFMVCash$200,000$200,000Land$400,000$475,000$600,000$675,000Shortly after Pedro became a partner, SPJ sold the land for $475,000. What are the tax consequences of the sale to Pedro and the partnership (1) assuming there is no Section 754 election in place, and (2) assuming the partnership has a valid Section 754 election?

Question

What will be an ideal response?

Answer 1

(1) The partnership has a $75,000 gain ($475,000 - $400,000) and $25,000 of this gain is allocated to Pedro. (2) Pedro's share of the basis of the land is increased by $25,000, the amount that he paid for the partnership interest in excess of the basis of the partnership assets. This basis increase is allocated entirely to the land. The partnership still has a $75,000 gain on the sale of the land, but Pedro's $25,000 share is eliminated by the 754 adjustment to the basis of the land (1/3 × 475,000) - [(1/3 × 400,000) + 25,000] = 0.