Partnership Contribution; Sale of Triplex & Residency Exclusion; Mutual Fund Sale, Loan Forgiveness as Gift

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, February 28, 1999

Copyright 1999 Robert L. Sommers, all rights reserved.

Question: : I formed an equal partnership with my brother. I contributed equipment with a $5,000 adjusted basis worth $10,000 and he contributed $10,000 in cash. How do we handle the potential $5,000 gain if the partnership sells the equipment?

Answer: If the partnership sells its equipment, the gain will allocated to you personally, because the FMV of the property was greater than your adjusted basis. Assume the partnership promptly sold your equipment for $10,000. The partnership would now have cash $20,000 ($10,000 from the sale of the equipment and $10,000 from your brother’s contribution). The taxable gain of $5,000 from the sale of the equipment ($10,000 received less $5,000 adjusted basis) would be allocated entirely to you.


Question: I own a triplex building with one unit as my residence. If I sell the property, will that portion qualify for the residency exclusion?

Answer: Yes, assuming you have owned and lived in the unit as your principal residence for at least 2 of the 5 years prior to the sale. You allocate the purchase price and adjusted basis on a per-unit basis. Assuming each unit was valued equally and you received $900,000 for the triplex with a $300,000 adjusted basis, your unit’s gain would be $200,000 — $300,000 (1/3 of the $900,000 proceeds) minus $100,000 basis (1/3 of your total adjusted basis) = $200,000, all of which is excluded from tax.

The balance of your $400,000 gain will be taxed as follows: You recapture any depreciation at 25% federal; the balance is taxed at 20%. California does not have a capital gains rate reduction. Note: You may use the tax-free exchange provisions of Internal Revenue Code Section 1031 to defer the gain on the rental units, in combination with your residency exclusion.


Question: I owned 1,500 shares of a mutual fund. I donated 100 shares, worth $25/share, to my church in 1996 (and claimed a charitable deduction of $2,500). In 1998, I sold 1,000 shares worth 27.50/share for $27,500. I still have 400 shares. How do I compute my adjusted basis for determining my 1998 gain?

Answer: The 100 shares donated in 1996 are no longer part of your portfolio. As to the 1,000 shares sold, the easiest way to calculate your gain is to compute the average basis of your remaining 1,400 shares under either the "double-category" or "single-category" methods.

The double-category divides shares by holding period into two categories, those held less than 12 months and those held longer. The basis in each category is then averaged. The single-category method combines all shares in the account; therefore, you keep track of the total basis of shares you own.

Remember, if dividends have been reinvested, you have received the money (and claimed it on your tax return) to buy more shares.

If you have kept accurate records, rather than using the average basis, you could employ the "first-in, first-out" (FIFO) method, which treats the first shares purchased as the first shares sold.


Question: May I sell property on an installment basis to my children and then decide each year whether or not to forgive $10,000 of the principal and interest as a gift?

Answer: Yes. Your annual gift-tax exclusion can be applied to the forgiveness of a genuine installment agreement, provided the amount forgiven is $10,000 or less ($20,000 for gifts made by a husband and wife) per year.

For example, if you make a $50,000 loan to your child at 6% interest, you can forgive the $3,000 interest and $7,000 principal (assuming your gift occurred 12 months later) by using your annual gift-tax exclusion. Note: Because the principal has now decreased to $43,000, the 6% interest accrual will be reduced. This permits your annual exclusion to reduce an ever-increasing percentage of the principal, although the interest continues to accrue during years you choose to change or skip your gifting.

If you forgave the entire loan after one year, then the $43,000 principal balance could be excluded by using a portion of your Unified Estate and Gift Tax Credit, generally worth $650,000 in 1999 (increasing to $1 million after 2006).




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