Under what conditions will a special allocation of partnership depreciation be recognized? Assume the partnership has no nonrecourse liabilities.
What will be an ideal response?
A special allocation must be stated in the partnership agreement or the amount will be allocated in accordance with the partners' interest in the partnership. In addition, the allocation must have substantial economic effect. To have economic effect, the allocation must meet all of the following requirements throughout the term of the partnership:
• Capital accounts must be maintained under the capital account maintenance rules of the Sec. 704 regulations.
• Upon liquidation of the partnership, liquidating distributions must be made in accord with positive capital accounts.
• If a partner has a deficit capital account balance after all adjustments for the year of liquidation, that partner must be unconditionally obligated to restore the deficit. (The regulations provide some alternatives to an unconditional obligation to restore the deficit, but the alternatives are not covered in this introductory textbook.)
For the economic effect of the special allocation to be considered substantial, there must be a reasonable possibility that the allocation will substantially affect the dollar amounts to be received by the partners independent of any tax consequences.
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