Partnership Accounting

[Harvey Lucas]

PartnershipQandA28Dec2010

Wheeler and Money are 50/50 partners in WMLLC 1065 Partnership.

They hire Widget Inc to manufacture a Widget that they will take into inventory and then will sell to a retail customer.

The Widget is a high ticket item and typically it takes 6 to 12 months to find a buyer.

Normally, Widget Inc would charge $120,000 to build the Widget.

Typically, WMLLC would sell the Widget to a retail customer for $150,000 to $200,000.

However, Wheeler is a great negotiator and he convinces Widget Inc to build the Widget for $60,000.

Money advances the entire $60,000 to Widget Inc in full payment of the agreed upon price.

Even tho Money has advanced 100% of the cost to manufacture the Widget, ie, $60,000, it is agreed that the true FMV to WMLLC is $120,000 and that Wheeler will get credit for one half of its value on the books of the WMLLC 1065 partnership so that Wheeler and Money can remain 50/50 partners.

The Widget is booked into inventory on the books of WMLLC at a value of $120,000. Money’s Capital account is increased by $60,000, ie the amount of cash that Money expended. Wheeler’s Capital account is also increased by $60,000 because it is agreed that the FMV is $120,000 and that Money and Wheeler will remain 50/50 partners on the deal.

Money’s outside basis in the Widget is $60,000, Wheeler’s outside basis in the Widget is zero.

If WMLLC later sells the Widget for $180,000, Money would report his share of the sale of $90,000 less his outside basis of $60,000 for a profit of $30,000.

Wheeler would report his share of the sale of $90,000, his outside basis is zero, so his share of the profit is $90,000.

Total profit on the sale is $120,000.

If there were no other income, expenses or transactions for the WMLLC 1065, Money’s K1 would show ordinary income of $30,000 and Wheeler’s K1 would show ordinary income of $90,000.

I am hoping that my analysis of this is correct, however, I do very little partnership work and I suspect that I may have missed the mark here with respect to how this works.

Also, I have tons of reference materials but can’t seem to find any examples that are specific enough to this scenario.

Any help would be greatly appreciated.

Sincerely,
Harvey Lucas

[BHoffman]

Hi Harvey - the true FMV of the Widget inventory is $60k because that is the price that was paid. I don't think we can simply revalue inventory at will to a price that is convenient.

What exactly are your clients trying to accomplish at the end of the day? Do they just want to shift taxable income from Money to Wheeler?

[dsi]

Sorry Harvey, but I'm with Bhoffman on this one. Think about it for a minute. It's inventory cost is what you paid for it, not what you think it is worth (or what someone else may have paid for it).

[Harvey Lucas]

Thanks guys.

What I am trying to accomplish is only to report it correctly based on the actual transaction that took place.

What I am struggling with is that the agreement between the partners is that they will both remain 50/50 partners in the deal even tho Money put in all the cash.

So how do I account for that on the books of the 1065?

Money wrote a check to Widget Inc for $60,000, so he is expecting $60,000 to show up as an increase in his capital account.

However, the agreement is that even tho Wheeler did not put up any money for the Widget, he is still given credit for an equal share of the partnership and it's assets.

It doesn't sound like a good deal for Money but that is what they agreed to.

So how can they remain 50/50 partners if I don't increase Wheeler's capital account for $60,000 like I did for Money's?

[taxxcpa]

Partners

They can be 50/50 partners in sharing profits and losses, but each partner has his own capital account which does not have to be 50%. The non-contributing partner has no BASIS so his only capital would be from earnings minus draws.

[taxxcpa]

Partners

They can be 50/50 partners in sharing profits and losses, but each partner has his own capital account which does not have to be 50%. The non-contributing partner has no BASIS so his only capital would be from earnings minus draws.

You can't create capital by contract terms or by recording a capital contribution when none was made--that would be a neat trick if you could create capital out of thin air.