"Small Business-Peachtree"

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Case Study: Small Business-Peachtree

This case study analyzes the situation of Peachtree, a newly formed business partnership between Toby and Nadia. We will explore Peachtree's entity choices, the implications of not making a Section 754 election, and the basis Toby should assign to the land and building he contributes to the partnership.

I. Entity Choices for Peachtree

Peachtree has several options for structuring their business entity. Here's a breakdown of the most common choices

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• Partnership: This is the current structure for Peachtree. Partnerships offer flexibility in management and profit-sharing but expose partners to unlimited personal liability for business debts.

• Limited Liability Partnership (LLP): Similar to a partnership, but with limited liability protection for partners against most business debts. Profits and losses pass through to partners' personal tax returns.

• Limited Liability Company (LLC): Offers limited liability protection similar to an LLP but with more flexibility in profit-sharing arrangements and management structure.

• C Corporation: A separate legal entity from its owners. Profits are taxed at the corporate level, and then again as dividends to shareholders. This can result in double taxation.

• S Corporation: Similar to a C Corporation, but elects to pass corporate income (losses) directly to shareholders' tax returns, avoiding double taxation. However, S Corporations have stricter ownership and operational limitations.

Form 8832 Election: Peachtree can consider filing Form 8832 with the IRS to be treated as an S Corporation for tax purposes. This can be beneficial if they expect to have net income and want to avoid double taxation.

Considerations:

• Management and Control: Partnerships offer more flexibility in management, while corporations have stricter governance structures.
• Liability Protection: LLCs and Corporations provide limited liability protection, while partnerships expose partners to personal liability.
• Taxation: C Corporations experience double taxation, while S Corporations and partnerships avoid it (profits/losses pass through to owners' tax returns).

II. Section 754 Election and Anti-Abuse Rules

Peachtree might choose not to make a Section 754 election for several reasons:

• No Substantial Built-in Loss: If the fair market value of Toby's contributed property (The Commons) is not significantly lower than its tax basis (original cost), there's no substantial built-in loss to adjust.

• Duplicate Loss Issue: Making a Section 754 election can create "duplicate loss" if Toby sells The Commons at a loss later. Peachtree can already deduct the entire loss, and the election would create an additional basis adjustment for Toby, potentially allowing him to deduct the loss twice.

Anti-Abuse Rules:

The "anti-abuse rules" in the regulations prevent taxpayers from manipulating the Section 754 election for tax advantages. These rules might restrict Peachtree's ability to deduct losses from the sale of The Commons if:

• The primary purpose of not making the election was to avoid the duplicate loss issue.
• The sale of The Commons happens soon after its contribution to the partnership.

Reference: Internal Revenue Code Section 754 and relevant Treasury Regulations.

III. Toby's Basis in the Land and Building

Toby's basis in the land and building he contributes to Peachtree will be the property's fair market value at the date of contribution. This becomes Peachtree's partnership basis in the property.

Tracing the Basis:

1. Original Cost: Start with the original cost Toby paid for the land and building.
2. Adjustments: Add any capital improvements made to the property (increases basis) and subtract any depreciation Toby claimed on his tax returns (decreases basis).
3. Fair Market Value: As of the contribution date, determine the fair market value of the land and building through appraisal or comparable sales data.

Basis Example:

• Original Cost of Land & Building: $100,000
• Capital Improvements: $20,000
• Depreciation Claimed: $10,000
• Adjusted Basis: $110,000
• Fair Market Value on Contribution Date: $120,000

Toby's basis in the contributed property would be $120,000 (fair market value) and this becomes Peachtree's partnership basis for the land and building.

Note: This is a simplified example, and the actual basis calculation might involve additional factors depending on specific circumstances.

Conclusion

Peachtree should carefully consider their business goals, liability protection needs, and tax implications when choosing an entity structure. The decision to make a Section 75